Mark-to-Market PFIC Election: When It Beats the Default Rules

The mark-to-market PFIC election under section 1296 lets a US taxpayer who owns marketable shares in a foreign fund pay ordinary income tax each year on the fund's increase in value, instead of waiting for a sale and paying top-rate tax plus interest under the default rules. It usually beats the default when made in the first year you own the fund. This guide explains who can make the election, how the yearly figures work, where the loss limits bite and when it is the wrong choice.

What is the mark-to-market PFIC election?

The mark-to-market election treats your PFIC shares as if you sold them at fair market value on the last day of each tax year. Under section 1296(a), if the value at year end exceeds your adjusted basis, the excess is included in gross income. If the value is below basis, you get a deduction, limited as explained below.

Section 1296(c) makes every amount ordinary: the yearly inclusion, any gain when you actually sell, and the allowed losses. Nothing is taxed at long-term capital gain rates. In exchange, the election removes the two features that make the default regime expensive: the allocation of gains to earlier years at the highest rate, and the interest charge on the deferred tax.

If you are not yet sure whether a holding is a PFIC at all, start with our guide to the PFIC definition. Most UK unit trusts, OEICs, investment trusts and UK-listed ETFs held by Americans meet the income or asset test.

How does it compare with the default section 1291 rules?

With no election, a PFIC is a section 1291 fund. Nothing is taxed while you hold it, but a gain on sale is spread over every day you held the shares. The slice for earlier years is taxed at the highest individual rate for each of those years, which the Instructions for Form 8621 list as 37% for 2018 through 2025, and interest is added. Our PFIC tax calculation article works through a full example.

	Default (section 1291)	Mark-to-market (section 1296)	Qualified electing fund
When tax arises	On sale or excess distribution	Every year, on the rise in value	Every year, on your share of the fund's earnings
Rate	Highest rate for each earlier year; your own rate for the current year	Your ordinary rate	Ordinary rate on ordinary earnings; capital gain rate on net capital gain
Interest charge	Yes	No (after the first election year)	No
Losses	Not taken into account under section 1291	Ordinary up to unreversed inclusions	Not passed through
What it needs	Purchase dates, costs and distribution history	Year-end values; the stock must be marketable	A PFIC Annual Information Statement from the fund
Cash to pay the tax	Only on sale	Every year, even if you sell nothing	Every year, even if nothing is paid out

Which funds count as marketable stock?

The mark-to-market election is available only for marketable stock. A fund that does not qualify is stuck with the default rules or a QEF election. Treasury Regulation section 1.1296-2 recognizes two main routes.

Shares regularly traded on a qualifying exchange

Stock is regularly traded if it trades, other than in de minimis quantities, on at least 15 days during each calendar quarter. The exchange must be a US national securities exchange registered with the SEC, or a foreign exchange that is regulated or supervised by a government authority and has meaningful listing, disclosure, trading volume and surveillance rules that are actually enforced. Investment trusts and ETFs listed on a major UK exchange are the usual candidates, but the trading test applies to each class of shares, so check it for the specific line you hold.

Open-ended funds that redeem at net asset value

Many UK unit trusts and OEICs are not traded on an exchange at all; you buy and sell units with the fund manager. The regulations treat shares in such a fund as marketable if, for the class you hold, all of these conditions are met:

• more than 100 unrelated shareholders at all times during the year;
• shares readily available to the general public at net asset value, with no minimum initial investment above $10,000;
• prices determined and published at least weekly in a widely available medium the fund does not control;
• financial statements prepared by independent auditors and made public at least annually;
• supervision or regulation as an investment company by a foreign government or its agency;
• no senior securities, apart from de minimis debt; and
• at least 90% passive gross income and at least 90% of average assets producing passive income.

Many UK retail funds sold on investment platforms look as if they meet these conditions, but that is a fact-by-fact question for each fund and share class. Keep a note on file of how each condition was satisfied in case the IRS asks.

How the yearly mark-to-market figures work

Part IV of Form 8621 carries the arithmetic. For shares still held at year end, lines 10a to 12 compare fair market value with adjusted basis. For shares sold during the year, lines 13a to 14c compute the gain or loss on the sale. Three rules drive the numbers.

1. Gain is included. If year-end value exceeds adjusted basis, the excess is ordinary income, reported on the "other income" line of Form 1040.
2. Loss is capped by unreversed inclusions. If adjusted basis exceeds year-end value, the deduction is the lesser of that excess and your unreversed inclusions. Section 1296(d) defines unreversed inclusions as the amounts included under the election in earlier years, less the deductions already allowed.
3. Basis moves with the income. Under section 1296(b), basis goes up by each amount included and down by each amount deducted, so the same growth is never taxed twice.

The election is made separately for each foreign corporation, and under Treasury Regulation section 1.1296-1(b)(3) it covers all marketable stock of that fund you own when you elect and any you buy later. Monthly purchases into the same fund therefore fall under one election, although each block still needs its own basis record.

A worked mark-to-market example

Illustrative example: Sam is a US citizen living in Bristol. On January 10, 2024 Sam buys shares in a UK-listed fund for the equivalent of $40,000, confirms that the shares are marketable stock, and makes the mark-to-market election on Form 8621 with the 2024 return. The figures ignore exchange rate movements and UK tax, and are not advice for any specific person.

Year	Value at year end or sale	Basis at start	Result	Unreversed inclusions after	Basis after
2024	$46,000	$40,000	$6,000 ordinary income	$6,000	$46,000
2025	$43,000	$46,000	$3,000 ordinary loss (within the $6,000 limit)	$3,000	$43,000
2026 (sold)	$38,000	$43,000	$5,000 loss: $3,000 ordinary, $2,000 under the general rules	$0	n/a

Over the three years Sam lost $2,000 in total. Sam was taxed on $6,000 of income in 2024, deducted $3,000 in 2025 and $3,000 in 2026 as ordinary losses, and has $2,000 of loss left over. The regulations treat that last $2,000 under the ordinary loss rules of the tax code; an example in Treasury Regulation section 1.1296-1 treats such an excess as a long-term capital loss where the shares were held for more than a year. Capital losses face their own limits against ordinary income, so the ordinary income from 2024 and the capital loss from 2026 do not fully cancel.

Had Sam made no election, the 2024 and 2025 movements would have been ignored and the sale at a loss would have produced no section 1291 tax. In a falling market, the default rules can be cheaper. In a rising market held for many years, the election usually wins, because it avoids both the top-rate allocation and the interest.

What happens if you elect after the first year?

An election made after you have already held the fund for a year or more as a section 1291 fund does not wipe out the past. Section 1296(j) and Treasury Regulation section 1.1296-1(i) say that for the first year the election applies:

• the excess of year-end value over adjusted basis is treated as if you sold the shares on the last day of the year, and the gain is taxed as an excess distribution under section 1291, with the top-rate allocation and the interest charge;
• distributions received and shares sold during that year are also dealt with under section 1291; and
• your basis is then increased by that gain, so normal mark-to-market treatment applies from the following year.

This is a one-off cost. It is often worth paying, because it stops the deferred tax and interest from growing, but it should be priced before the election is made. The exception is a fund that was a qualified electing fund for you for every earlier year of the holding period: then section 1291 does not apply in the first election year.

When does the mark-to-market election beat the default rules?

The mark-to-market election tends to come out ahead in these situations:

• You are buying a fund now and expect to hold it for years. Electing in the first year means there is never a section 1291 year to deal with.
• The fund is expected to grow. Rising values are exactly what the default rules punish, through the interest charge on each year's slice.
• You invest monthly. Under the default rules every purchase is a separate block with its own holding-period allocation. Under the election, each block is still valued every year, but there is no allocation and no interest calculation.
• The fund will not provide a PFIC Annual Information Statement, so a QEF election is not possible. Our article on HMRC reporting funds explains why UK reporting fund status alone does not satisfy the QEF rules.
• You hold funds in an ISA. GOV.UK describes ISAs as tax-free in the UK, but the US ignores the wrapper. Our guide to ISAs and PFICs covers the US side.

It is a poorer fit when the fund is volatile and you may sell at an overall loss, when you need the cash and paying tax on unrealized gains each year would be hard, or when you plan to sell within a short time anyway.

The UK side: a timing mismatch to plan for

The UK does not tax an unrealized gain on fund units. For a US citizen living in the UK, that creates a timing mismatch. The mark-to-market election taxes growth in the US year by year, while the UK taxes the gain, if at all, only when the units are sold. A UK tax paid on the eventual sale may fall in a year when there is little or no US gain left to credit it against, because most of the growth has already been taxed in the US in earlier years.

That does not make the election wrong, but it means the US and UK returns should be planned together. Holding PFICs in an ISA avoids the UK tax entirely, so there is no mismatch there, though the US tax still has to be paid from other money.

How to make the mark-to-market election on Form 8621

1. Confirm the fund is a PFIC and the shares are marketable stock for the year, and keep a short note of the evidence.
2. Get the year-end fair market value in dollars and your adjusted basis for each block of shares.
3. Complete a separate Form 8621 for the fund, check box C in Part II, and complete Part IV; or Part V instead for a first election year to which section 1291 applies.
4. Attach it to a timely filed return. The Instructions for Form 8621 say the election must be made by the due date, including extensions, of the return for that year.
5. Carry the figures forward. Record the new basis and the unreversed inclusions; next year's loss limit depends on them.

The About Form 8621 page links to the current form and instructions. Our Form 8621 instructions guide walks through the rest of the form, including when Part I is required.

What people get wrong about the mark-to-market PFIC election

• Assuming a late election cleans up the past. The first election year is still taxed under section 1291 if the fund was a section 1291 fund before.
• Expecting capital gains rates. All mark-to-market income and all gain on sale is ordinary income.
• Deducting every fall in value. A decline is deductible only up to unreversed inclusions; a fund that falls in its first election year produces no deduction at all.
• Electing for a fund that is not marketable. The election is only valid for marketable stock, so check the trading or net asset value conditions first.
• Treating it as a one-year choice. The election continues for all later years and can only be revoked with IRS consent.
• Forgetting the cash. Tax is due on gains you have not received, so plan where the money will come from.

How we help

US/UK Cross Border Tax is a firm of US CPAs and UK tax advisers working as one team, with offices in London, Manchester, New York and San Francisco. We review each fund you hold, check whether it qualifies as marketable stock, price the cost of making a mark to market PFIC election now against staying in the default regime, and prepare every Form 8621 as part of our PFIC reporting work alongside your US and UK returns. For cross-border investors deciding what to buy next, our guide to investing as an American in the UK sets out the alternatives. To have your own funds reviewed before your next filing deadline, contact us.