Alert: Mark-to-Market Tax Election Deadline for Partnerships

This alert is intended as a reminder that the deadline for many investment funds organized as partnerships to make an election to mark securities and/or commodities positions to market under Section 475(f) of the Internal Revenue Code of 1986, as amended to date (the “Code”) is today, March 16, 2020. Given recent market volatility, certain funds may have particular interest in considering such an election for 2020.

Funds whose activities constitute for U.S. federal income tax purposes a trade or business of trading in securities and/or commodities (as distinguished from activities as an investor) are eligible to elect to “mark-to-market” their securities and/or commodities positions in connection with such trade or business under Section 475(f) of the Code. Any decision to make such an election should be made by a fund in consultation with its tax advisers and tax return preparers in order to review the tax characteristics of the fund’s assets and the fund’s other particular circumstances, and taking into account that such an election would apply at least until the end of the 2020 tax year.

Such an election results in most, if not all, of such an electing fund’s securities positions or commodities positions, respectively, being deemed sold for U.S. federal income tax purposes at the end of the fund’s taxable year. The gain or loss from actual sales during the year and from deemed sales at the end of the year as a result of the election would generally be treated as ordinary income or loss, instead of capital gain or loss, even if the property sold or deemed sold would have been treated as a capital asset in the absence of the election. Gains accrued prior to the beginning of the first year for which the election is in effect would be included in income under Section 481(a) of the Code, generally over a four-year period beginning with the year of the election, while historic losses generally would be recognized in such first year.

In general, for U.S. federal income tax purposes, capital losses may not be deducted against ordinary income, but only against capital gains. Unused net capital losses at the end of a tax year generally may be carried over to future years in which they may be deducted against capital gains in such future years (subject to generally applicable limitations). A mark-to-market election, under which, as noted above, actual and deemed sales of securities and/or commodities would produce ordinary, rather than capital, gain or loss, may in certain circumstances allow a fund to avoid a mismatch between significant ordinary income (e.g., from interest or from certain swaps) that cannot be offset by what may be significant capital losses (e.g., from the sale of securities and/or commodities that have declined in value).

A mark-to-market election under Section 475(f) of the Code generally also inactivates the application of the “wash sale” and “straddle” rules under Sections 1091 and 1092 of the Code, respectively. In the absence of a mark-to-market election, these rules generally serve to defer the recognition of certain losses. Thus a mark-to-market election may allow the recognition of certain losses in the year of election that would otherwise be unavailable.

It is important to note that other loss limitation rules, including, for example, those applicable to “excess business losses,” may still be applicable to losses otherwise treated as recognized pursuant to a mark-to-market election.

The deadline for making a mark-to-market election under Section 475(f) of the Code for given a tax year generally is the due date (without regard to extensions) of the taxpayer’s U.S. federal tax return for the preceding year. An election for a partnership for its 2020 calendar tax year must be made by today, Monday, March 16, 2020, by attaching a statement containing such election to the partnership’s extension request for filing its 2019 U.S. federal tax return (IRS Form 7004) or to the 2019 U.S. federal tax return itself if the return is filed by March 16, 2020. An individual or a corporation with a calendar year tax year generally would have until April 15, 2020 to make this election.

The Internal Revenue Service has not announced whether it will grant extensions for making mark-to-market elections (or for filing tax returns generally) to taxpayers in connection with the COVID-19 pandemic. In the absence of such an announcement, a partnership that wants to be sure a mark-to-market election is effective for its 2020 tax year should make such election by today, March 16, 2020. Importantly, a Section 475(f) election timely made for 2020 would be effective for all of 2020 and any future tax year, although a partnership may elect to revoke the election for a future year by filing a notice by the due date for the preceding year’s return. Following such a revocation an additional mark-to-market election could be made only with the consent of the IRS for a period of five years beginning with the year of revocation.

For more information about this alert, please contact Seth Lebowitz at 212-573-8152 or your usual contact at Sadis & Goldberg LLP.