Section 1256 contracts are a specific category of financial instruments defined by the IRS. These contracts are subject to special tax rules and must be reported on Form 6781: Gains and Losses From Section 1256 Contracts and Straddles.
Mark-to-Market Rule
Under the Mark-to-Market rule, each Section 1256 contract held at the end of the tax year is treated as if it were sold at its fair market value on the last business day of the year. This means:
- You must report any unrealized gains or losses as if the contract was sold.
- These gains or losses are included in your tax return for that year.
Tax Treatment of Gains and Losses
Gains or losses from Section 1256 contracts are taxed using a 60/40 split, regardless of how long the contract was held:
- 60% is treated as long-term capital gain or loss
- 40% is treated as short-term capital gain or loss
However, if you designate a Section 1256 contract as a hedge at the time you enter into it, any realized gains must be reported as ordinary income.
Types of Section 1256 Contracts
The following are commonly classified as Section 1256 contracts:
- Non-equity options
- Foreign currency contracts
- Regulated futures contracts
- Dealer equity options
- Dealer securities futures contracts
What Is a Straddle?
A straddle occurs when you hold offsetting positions in actively traded personal property. For example, buying both a call and a put option on the same security at the same time. Special tax rules apply to straddles, and they must also be reported on Form 6781.
Program Entry
To report Section 1256 contracts in your tax software:
- Go to the Federal section
- Select Income > Select my forms
- Choose Less Common Income
- Select Form 6781 - Gains and Losses From Section 1256 Contracts
Additional Information
For more information, refer to IRS Form 6781 Instructions.