SECTION 1256 CONTRACTS
A Section 1256 Contract is any:
(1) Regulated Futures Contract
(2) Foreign Currency Contract
(3) Nonequity option
(4) Dealer equity option
Section 1256 Contracts are subject to special tax rules.
Section 1256 contracts are marked-to-market by law, which means that a contract held at
the end of the tax year is treated as if sold at its fair market value on the last
business day of the year and you must include this unrealized gain or loss in your taxable
income for the year. This unrealized gain or loss becomes an adjustment to the cost basis
and reverses itself in the following year when the contract is actually sold.
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. Gain or loss and the 60/40 split from these contracts are reported on IRS
Due to the volatile nature of these securities, a special loss
carryback election is allowed. Net Section 1256 Contracts 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 carryback year first and any unabsorbed loss can
then be carried to each of the next two years.
A wash sale occurs when you sell or trade stock or
securities at a loss and within 30 days before or after the sale you:
(1) Buy substantially identical stock or securities
(2) Acquire substantially identical stock or securities in a fully taxable trade
(2) Acquire a contract or option to buy substantially identical stock or securities
Losses from wash sales are not deductible. The disallowed
loss is added to the cost of the new stock or securities, resulting in a new basis for
gain or loss for the new security. This adjustment has the effect of postponing the loss
deduction until the disposition of the new security.
Almost all day traders have numerous wash sales during the
year, as they tend to trade the same security or basket of securities over and over. If
these wash sales are recorded properly, they become a record keeping nightmare.
One of the advantages of a Section 475 election is that
wash sale rules no longer apply to a qualified trader who has properly elected Section