Section 1256 contracts are used by the IRS to assign a specific category of investments. These contracts are reported to the IRS on Form 6781.
Under the Mark-to-Market rules, each 1256 contract held at the end of the year should be treated as if it were sold at its fair market value on the last business day of the tax year. You then report the gains or losses on your tax return each year.
Capital gains or losses on Section 1256 contracts, either open at the end of the year or terminated at some point during the year, are regarded as 60% long term and 40% short term, in spite of how long the contracts were held. However, if you classify a Section 1256 contract as a hedge at the moment when you entered into it, you must report any realized gains as ordinary income.
Securities that are regarded as Section 1256 investments include:
- non-equity options
- foreign currency contracts
- regulated futures contracts
- dealer equity options
- dealer securities futures contracts
A straddle exists when you make counteracting positions on personal properties that are actively traded (both a call and put option for the same security at the same time).