Regulated futures contracts tax reporting
Reporting capital gains from futures trading is not quite the same as when trading stocks and options. Capital gains from trading IRS Section 1256 contracts such as commodity futures, index futures, and broad-based index options are reported by your brokerage 1099-B (or 1099-C for tax years prior to 2006).
What is a futures contract?
According to IRS Publication 550:
A commodity futures contract is a standardized, exchange-traded contract for the sale or purchase of a fixed amount of a commodity at a futures date for a fixed price. If the contract is a regulated futures contract, the rules described under Section 1256 contracts marked to market apply to it. The termination of a commodity futures contract generally results in capital gain or loss.
What is a Section 1256 Contract?
A Section 1256 contract is any:
- Regulated futures contract,
- Foreign currency contract,
- Non-equity option,
- Dealer equity option, or
- Dealer securities futures contract.
IRS Publication 550, under the Non-equity option heading:
Non-equity options include debt options, commodity futures options, currency options, and broad-based stock index options. A broad-based stock index is based upon the value of a group of diversified stocks or securities (such as the Standard and Poor's 500 index).
Good news for active traders:
The good news for traders of Section 1256 contracts is twofold:
- 60% of the capital gain or loss from Section 1256 Contracts is deemed to be long-term capital gain or loss and 40% is deemed to be short-term capital gain or loss. What this means is a more favorable tax treatment of 60% of your gains.
- A special loss carry-back election is allowed. Section 1256 contract net losses can be carried back 3 years instead of being carried forward to the following year. These losses can only be carried back to a year in which there is a net Section 1256 contracts gain, and only to the extent of such gain, and cannot increase or produce a net operating loss for the year. The loss is carried back to the earliest carry-back year first and any unabsorbed loss can then be carried to each of the next two years. So if you have a net loss for the year, you can amend a previous year's tax return and possibly get a refund!
Section 1256 contracts are reported on IRS Form 6781. Part I, Line 2 of this form simply asks for your total gain or loss, and then it splits this loss as 40% short-term on Line 8, and 60% long-term on Line 9. These entries then flow to your Schedule D - Part I, Line 4 for short-term capital gains and Part II, Line 11 for long-term capital gains.
No additional detail or complex matched trade report (as required for capital gains from stock, options, etc.) is required.
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