Mark-to-Market Election Is Not a Disposition for PAL Purposes

Sec. 1(h) provides a reduced capital-gain rate for qualified five-year gain. Sec. 1(h)(2)(B)(ii) limits the amount of that gain by taking into account only property for which the holding period begins after 2000. Under Section 311(e) of the Taxpayer Relief Act of 1997 (TRA '97), a noncorporate taxpayer may elect to treat a capital asset or property used in a trade or business (as defined in Sec. 1231(b)), held by the taxpayer on Jan. 1, 2001, as sold on Jan. 1, 2001 for its fair market value (FMV), and as reacquired for its FMV on the same date (a mark-to-market election).

According to Sec. 469(g)(1)(A), if a taxpayer disposes of his entire interest in any passive activity (or former passive activity) in a fully taxable transaction that does not involve a disposition to a related party, the excess of the loss from the activity for the tax year (including any suspended passive activity loss (PAL)) over any net income or gain for the tax year from all other passive activities would not be a PAL. As a result, if Sec. 469(g)(1)(A) applies, the excess loss from the activity over any net income from all passive activities will no longer be subject to Sec. 469 limits.

A question has arisen about whether electing a deemed sale of property under TRA '97 Section 311(e) is treated as a disposition under Sec. 469(g)(1)(A).

In a technical correction to Section 311(e), the Job Creation and Worker Assistance Act of 2002 clarifies that a mark-to-market election is not a disposition for Sec. 469(g)(1)(A) purposes. Thus, the gain included in gross income for a mark-to-market election may be passive-activity gross income that can be offset by passive-activity deductions, but the election does not otherwise affect the determination of the PAL disallowed under Sec. 469.

Notice 2002-29, IRB 2002-17