If you traded certain futures, options, or foreign currency contracts during the year, you may need to file Form 6781, Gains and Losses From Section 1256 Contracts and Straddles. These investments receive special tax treatment under IRS rules and are reported differently than most stocks and securities.
Understanding how Section 1256 contracts work can help you report your gains and losses correctly and avoid surprises at tax time.
What Is a Section 1256 Contract?
A Section 1256 contract is a specific type of investment that the IRS taxes under special rules. Common examples include:
- Non-equity options
- Foreign currency contracts
- Regulated futures contracts
- Dealer equity options
- Dealer securities futures contracts
Because these investments often trade in highly active markets, the IRS requires taxpayers to follow unique reporting and valuation rules.
How the Mark-to-Market Rule Works
Section 1256 contracts are subject to the mark-to-market rule.
This means that on the last business day of the tax year, any Section 1256 contract you still own is treated as though it were sold for its fair market value, even if you did not actually sell it.
As a result:
- Unrealized gains must be reported as taxable gains.
- Unrealized losses may be reported as deductible losses.
- These amounts are included on your tax return for that year.
In other words, the IRS taxes your year-end gain or loss whether the contract was actually sold or not.
How Section 1256 Gains and Losses Are Taxed
One of the key benefits of Section 1256 contracts is their favorable tax treatment.
Regardless of how long you held the contract:
- 60% of the gain or loss is treated as a long-term capital gain or loss
- 40% is treated as a short-term capital gain or loss
This is commonly known as the 60/40 rule.
For many taxpayers, this treatment can result in a lower tax rate than ordinary short-term capital gains, which are generally taxed at regular income tax rates.
Hedging Exception
If you properly designate a Section 1256 contract as a hedge when you enter into the position, any realized gain may need to be reported as ordinary income rather than receiving the standard 60/40 capital gain treatment.
What Is a Straddle?
A straddle occurs when you hold offsetting positions in actively traded personal property.
For example, purchasing both a call option and a put option on the same security may create a straddle.
Because one position can offset gains or losses in the other, the IRS applies special reporting and loss-deferral rules to straddles. These transactions are also reported on Form 6781.
How to Report Section 1256 Contracts in the Program
To enter Form 6781 information in the software:
- Go to Federal.
- Select Income (Select my forms).
- Choose Less Common Income.
- Select Form 6781 – Gains and Losses From Section 1256 Contracts and Straddles.
- Enter the information from your Form 6781 or brokerage statements.
Be sure your brokerage records match the amounts being reported, especially if year-end mark-to-market adjustments were made.
Additional Information
For detailed guidance on reporting Section 1256 contracts and straddles, review the official IRS instructions for Form 6781 and any tax documents provided by your broker.