709 / How are gains and losses calculated for “traders in securities” when securities are sold subject to nonrecourse liabilities and the mark-to-market rules apply?

If a taxpayer who is a securities dealer uses the mark-to-market rules under IRC Section 475(f)(1) with respect to sales of securities held in connection with his or her business, the IRS has provided guidance requiring that the amount of any nonrecourse liabilities be included when calculating the fair market value of the securities.

The IRS has addressed a situation where two partnerships originated and purchased mortgage loans and issued notes to third-party investors as mortgage-backed securities. The mortgage-backed securities were subject to nonrecourse liabilities. One partnership sold the securities to a third partnership, including the amount of the nonrecourse liabilities when calculating the amount realized in the sale. The purchasing partnership also included the nonrecourse liabilities when calculating its basis in the securities.¹

Both partnerships used mark-to-market accounting under IRC Section 475. However, the partnerships failed to include the value of the nonrecourse liabilities when calculating the fair market value of the securities for purposes of determining year-end gain or loss under the mark-to-market rules. In requiring that the partnerships include the nonrecourse liabilities in calculating fair market value, the IRS found that the fair market value of the property could be no less than the amount of any nonrecourse indebtedness to which the property is subject when determining gain or loss.² The IRS found further that even if the Internal Revenue Code does not mandate this conclusion, Supreme Court precedent requires inclusion of any nonrecourse debt in determining fair market value for purposes of the mark-to-market rules.³