Editor’s Note: Section 1256 contracts are reported on form 6781. Learn more about these contracts and how they should properly be reported to the IRS in this post.
What Is the Purpose of Section 1256 Contracts?
Section 1256 contracts prevent tax-motivated straddles that:
- Defer income
- Convert short-term capital gains into long-term capital gains
To do so, Section 1256 requires that these contracts be reported using mark-to-market rules. You might hold Section 1256 contracts at the end of the year. If so, they’re treated as if they were sold at their fair market value (FMV) on the last business day of the year. This applies even though you still owned the contracts.
Gains and losses from the open contracts are recorded as 60% long-term and 40% short-term. This applies no matter how long you held the contracts. When the Section 1256 contract ends, the gain or loss is adjusted for the previous gain or loss
What Do Section 1256 Contracts Include?
Section 1256 contracts include:
- Regulated futures contracts, like commodities futures
- Foreign-currency contracts that are publicly traded
- Nonequity options
- Dealer-equity options
- Dealer securities futures contracts
Use Tax Form 6781 For Open Section 1256 Contracts
Use tax form 6781, Part I to report the gains and losses on open Section 1256 contracts.
A straddle is when you hold contracts that offset the risk of loss from each other. You might realize a loss when you sell part of a straddle position. If so, you must reduce your loss by any recognized gain in the offsetting position. Any loss you can’t currently deduct is carried over to the next tax year. Straddle-loss rules and exceptions are complicated.
How to Fill Out Tax Form 6781
Here are the steps to fill out tax form 6781:
- Download and print form 6781 on IRS.gov.
- Add your name shown on tax return, identifying number and check applicable boxes:
- (A) Mixed straddle election,
- (B) Straddle-by-straddle identification election,
- (C) Mixed straddle account election,
- (D) Net section 1256 contracts loss election. Elections impact how you fill out form 6781; see the form instructions for more information. You can choose only one election from among (A), (B), and (C).
- Fill out Part I Section 1256 Contracts Marked to Market, lines one through nine.
- Fill out Part II Gains and Losses From Straddles. Attach a separate statement listing each straddle and its components. This includes lines 10 through 13.
- Fill out Part III Unrecognized Gains From Positions Held on Last Day of Tax Year, line 14.
More Help Completing IRS Form 6781
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