Bulletin board…

🔬 Call for papers… Nathan Sosner, a principal at AQR, is Special Section Editor for the Journal of Wealth Management’s Fall 2026 issue. Submit a paper by Feb 1, 2026.

🎉 Basis Northwest is my taxable wealth conference. It’s in Seattle in 2026.

Disclaimer: This article discusses the taxation of hedge funds. It is educational and not investment, tax, or legal advice. Consult a credentialed adviser for personalized guidance.

Mentioned herein…

• Miller, David S., and Jean Bertrand. “Federal Income Tax Treatment of Hedge Funds, Their Investors, and Their Managers.” The Tax Lawyer 65, no. 2 (2012): 309–98. (MB 2012)
• Sosner, Nathan, and Roxana Steblea-Lora. “Limitation on Trader Fund Losses under the CARES Act of 2020.” The Journal of Wealth Management, vol. 24, no. 3, Winter 2021, pp. 71-89. (SS 2021)
• Sosner, Nathan, Philip Balzafiore, and Zhenduo Du. “Partnership Allocations and Their Effects on Tax-Aware Fund Investors.” The Journal of Wealth Management, vol. 21, no. 1, Summer 2018, pp. 8-17. (SBD 2018)
• Internal Revenue Service. Instructions for Form 461 (2023) (IRS 461)

Trader fund losses can offset ordinary income, but must pass through a gauntlet

A “trader fund” is a hedge fund that has made the annual determination that it qualifies as a “trader” rather than as an “investor.”

These funds are very popular nowadays for their diversification properties and tax-awareness (long-overdue in hedgefundland), though they are usually only available to accredited investors, who are also qualified purchasers, and who work with advisers.

A “trader fund” is not necessarily a “trader in securities,” the (somewhat) familiar mark-to-market §475 election. These are different things.

I wrote about the trader determination versus the trader in securities election a few days ago.

“Conceptually, a trader is someone who aims for rapid portfolio turnover, whereas an investor is someone who tends to hold securities for a longer duration.” (MB 2012)

The trader determination is all about whether fund expenses are deductible.

“it suffices to say that from the management fee deductibility perspective the TCJA made trader funds more appealing for taxable investors than investor funds.” (SS 2021)

Business losses from trader funds can also offset ordinary income, including wages, but only up to the annual Excess Business Loss (EBL) limitation threshold (excess amounts carry forward as net operating losses).

Wait… Aren't limited partners in hedge funds passive investors, and thus unable to offset ordinary income with business losses?

No.

And here's why…