What Are Section 1256 Contracts?
Section 1256 contracts are specific types of derivatives that receive favorable tax treatment under IRC Section 1256. These contracts are automatically marked-to-market at year-end and taxed under the special 60/40 tax rate split regardless of actual holding period.
This tax treatment can result in significantly lower tax rates compared to ordinary income treatment or standard short-term capital gains.
✓ Key Advantage
Section 1256 contracts receive automatic 60% long-term / 40% short-term capital gains treatment, regardless of how long you hold them. This can reduce your effective tax rate from 37% (ordinary income) to as low as 26.8% for high earners.
Statutory Definition
Under IRC Section 1256(b), a Section 1256 contract includes:
- Regulated futures contracts - Exchange-traded futures on commodities, indices, currencies
- Foreign currency contracts - Certain forex contracts traded on regulated exchanges
- Non-equity options - Options on futures, commodities, currencies, and broad-based indices
- Dealer equity options - Listed options traded by dealers
- Dealer securities futures contracts - Specific contracts held by dealers
⚠ Not Section 1256
Stock options, equity options (like SPY, AAPL options), individual stock futures, and most crypto spot trading do NOT qualify for Section 1256 treatment. Only specific derivatives qualify.
60/40 Tax Treatment Explained
The hallmark of Section 1256 treatment is the 60/40 split: 60% of gains/losses are treated as long-term capital gains/losses, and 40% are treated as short-term, regardless of your actual holding period.
Tax Rate Comparison
| Income Level | Ordinary Income Rate | Short-Term Cap Gains | Long-Term Cap Gains | 1256 Blended Rate | Savings vs. Ordinary |
|---|---|---|---|---|---|
| $50,000 | 22% | 22% | 15% | 17.8% | 4.2% |
| $100,000 | 24% | 24% | 15% | 18.6% | 5.4% |
| $200,000 | 32% | 32% | 15% | 21.8% | 10.2% |
| $500,000+ | 37% | 37% | 20% | 26.8% | 10.2% |
Calculation Example
Assume you're in the 37% tax bracket and make $100,000 from trading E-mini S&P 500 futures:
💰 Without 1256 Treatment
Short-term gains: $100,000 × 37% = $37,000 tax
✅ With 1256 Treatment
60% LT (20%): $60,000 × 20% = $12,000
40% ST (37%): $40,000 × 37% = $14,800
Total tax: $26,800
Tax savings: $10,200 (27.5% reduction)
Mark-to-Market Year-End Rules
Section 1256 contracts are subject to mandatory mark-to-market (MTM) accounting. This means all open positions are deemed sold at fair market value on December 31st, even if you don't actually close them.
How MTM Works
- Deemed sale on Dec 31: All open Section 1256 contracts are treated as if sold at FMV on the last trading day
- Recognize unrealized gains/losses: You report paper profits and losses on your current year tax return
- Adjusted basis in next year: On Jan 1, your contracts have a new cost basis equal to the Dec 31 FMV
- 60/40 treatment applies: All MTM gains/losses receive the 60/40 split
💡 Important MTM Implications
You pay tax on unrealized gains. If you have open profitable positions on Dec 31, you'll owe tax even though you haven't sold. This requires careful year-end planning to ensure sufficient cash for tax payments.
MTM Example
| Date | Action | Position Value | Tax Consequence |
|---|---|---|---|
| Oct 15, 2025 | Buy 10 ES futures @ $4,500 | $2,250,000 | None |
| Dec 31, 2025 | MTM (FMV = $4,700) | $2,350,000 | Report $100,000 gain on 2025 return |
| Jan 1, 2026 | New basis = $4,700 | $2,350,000 | Basis reset to FMV |
| Feb 10, 2026 | Sell @ $4,800 | $2,400,000 | Report $50,000 gain on 2026 return |
Qualified vs. Non-Qualified Contracts
Not all derivatives qualify for Section 1256 treatment. The distinction between qualified and non-qualified contracts is critical for tax planning.
Qualified Section 1256 Contracts
✅ Regulated Futures
E-mini S&P 500, crude oil, gold, wheat, treasury bond futures - all exchange-traded futures
✅ Index Options
SPX, VIX, RUT options (broad-based index options, not ETF options)
✅ Forex Contracts
Regulated foreign currency contracts on qualified exchanges (CME, ICE)
✅ Options on Futures
Options on any qualified futures contract (e.g., options on /ES, /CL)
Non-Qualified Contracts (Standard Capital Gains Treatment)
❌ Equity Options
SPY, QQQ, AAPL, TSLA options - individual stock or ETF options
❌ Stock Futures
Single-stock futures (though rarely traded in US)
❌ OTC Derivatives
Over-the-counter swaps, forwards not traded on regulated exchanges
❌ Retail Forex
Forex trading through retail brokers (unless you elect out under IRC 988)
Futures, Options, and Forex Details
Regulated Futures Contracts
The most common Section 1256 contracts. All exchange-traded futures qualify, including:
- Index futures: E-mini S&P 500 (/ES), Nasdaq 100 (/NQ), Dow (/YM), Russell 2000 (/RTY)
- Commodity futures: Crude oil (/CL), gold (/GC), natural gas (/NG), wheat (/ZW)
- Interest rate futures: 10-Year Treasury (/ZN), 30-Year Bond (/ZB), Eurodollar
- Currency futures: Euro (/6E), Yen (/6J), Bitcoin futures (/BTC on CME)
Non-Equity Options
Options qualify for Section 1256 treatment if they are on broad-based indices or futures contracts:
| Option Type | Example | Section 1256? | Reason |
|---|---|---|---|
| Broad-based index options | SPX, VIX, RUT, NDX | YES | Cash-settled, broad index |
| ETF options | SPY, QQQ, IWM | NO | ETF is a security, not an index |
| Equity options | AAPL, TSLA, GOOGL | NO | Options on individual stocks |
| Options on futures | /ES options, /GC options | YES | Underlying is a 1256 contract |
💡 SPX vs. SPY
SPX options (S&P 500 Index) receive Section 1256 treatment. SPY options (SPDR S&P 500 ETF) do NOT - they're taxed as regular equity options. This is a key planning distinction for index traders.
Foreign Currency Contracts
Forex taxation is complex. Section 1256 treatment depends on how you trade:
- Regulated futures contracts (CME, ICE): Section 1256 treatment automatically applies
- Retail spot forex (FXCM, OANDA): Default is IRC Section 988 ordinary gain/loss treatment
- Internal Revenue Code Section 988(a)(1)(B) election: You can elect OUT of Section 988 and INTO capital gains treatment, but NOT Section 1256
- Planning tip: Trade forex futures (e.g., /6E) on regulated exchanges to get Section 1256 treatment
Mixed Straddle Elections
A straddle exists when you hold offsetting positions that reduce risk. A mixed straddle combines Section 1256 contracts with non-Section 1256 positions (e.g., SPX options + SPY stock).
Why Mixed Straddles Matter
Without an election, straddle rules can defer losses and create unfavorable tax timing. Mixed straddle elections allow you to choose how to tax the entire position.
Three Mixed Straddle Election Options
① Mixed Straddle Account
Elect to treat all positions in a designated account as non-Section 1256. Loses 60/40 treatment but simplifies accounting.
② Straddle-by-Straddle ID
Identify specific straddles and elect to net gains/losses across Section 1256 and non-1256 legs. Complex but flexible.
③ Net Section 1256 Treatment
Convert the entire straddle (including equity positions) to Section 1256 treatment if >50% is from 1256 contracts.
⚠ Complexity Warning
Mixed straddle elections are highly technical and require contemporaneous record-keeping. Consult a tax professional before making these elections - mistakes can be costly and difficult to correct.
When to Consider Mixed Straddle Elections
- Hedged positions: You regularly hold offsetting positions across contract types (e.g., SPX calls + SPY stock)
- Complex strategies: Multi-leg spreads combining 1256 and non-1256 contracts
- Loss harvesting: You want to recognize losses immediately rather than having them deferred
- Simplified accounting: You prefer consistent treatment across all positions in an account
Reporting on Form 6781
All Section 1256 contract gains and losses are reported on IRS Form 6781 (Gains and Losses From Section 1256 Contracts and Straddles).
Form 6781 Structure
The form has two main parts:
- Part I: Section 1256 contracts marked to market
- Part II: Gains and losses from straddles
Step-by-Step Filing Guide
1Obtain your 1099-B from broker
Your broker (Interactive Brokers, TD Ameritrade, etc.) will issue Form 1099-B reporting all Section 1256 transactions. This form will show aggregate profit/loss.
2Complete Form 6781, Part I
Enter your total Section 1256 gains or losses on Line 1. This includes both realized gains/losses from closed positions AND unrealized MTM gains/losses from open positions on Dec 31.
3Apply the 60/40 split
Line 8: Enter 60% of Line 1 (long-term capital gain/loss)
Line 9: Enter 40% of Line 1 (short-term capital gain/loss)
4Transfer to Schedule D
60% portion goes to Schedule D, Line 11 (long-term gains/losses)
40% portion goes to Schedule D, Line 4 (short-term gains/losses)
5Calculate total tax on Schedule D and Form 1040
Schedule D flows to Form 1040, where it combines with your other income to calculate total tax liability.
Sample Form 6781 Calculation
💡 Broker Aggregation
Most brokers aggregate all your Section 1256 transactions into a single gain/loss figure on Form 1099-B. You typically don't need to list each individual trade - just report the totals on Form 6781.
Loss Carrybacks
One powerful feature of Section 1256 contracts: net capital losses can be carried back 3 years to offset prior Section 1256 gains, potentially generating immediate tax refunds.
How Loss Carrybacks Work
- Incur a net Section 1256 loss in the current year
- File Form 6781 and Form 1045 (Application for Tentative Refund) or amended returns (Form 1040-X) for the 3 prior years
- Carryback the loss to offset Section 1256 gains in those years (earliest year first)
- Receive a refund of taxes previously paid on those gains
✓ Powerful Tax Planning Tool
Unlike standard capital losses (which can only offset $3,000 of ordinary income per year and carry forward), Section 1256 losses can be carried back to generate immediate cash refunds. This is particularly valuable in volatile trading years.
Carryback Example
| Year | Section 1256 Gain/Loss | Tax Paid (26.8% blended) | After Carryback |
|---|---|---|---|
| 2022 | +$100,000 gain | $26,800 | $0 gain after carryback → $26,800 refund |
| 2023 | +$50,000 gain | $13,400 | $0 gain after carryback → $13,400 refund |
| 2024 | +$25,000 gain | $6,700 | $0 gain after carryback → $6,700 refund |
| 2025 | -$200,000 loss | $0 | Carry back $175,000 to offset prior gains $25,000 carries forward to 2026+ |
Total refund: $46,900 received by filing Form 1045 or amended returns.
Carryback vs. Carryforward Election
You can elect to waive the carryback and only carry losses forward if:
- You expect higher tax rates in future years
- You had little or no Section 1256 gains in prior years
- You want to simplify your tax filings (carrybacks require amending prior returns)
Trader vs. Investor Treatment
Section 1256 treatment applies regardless of whether you're classified as a trader or investor. However, your classification affects other aspects of your tax situation.
Key Differences
| Tax Issue | Investor | Trader (TTS) |
|---|---|---|
| Section 1256 gains/losses | 60/40 treatment on Form 6781 | 60/40 treatment on Form 6781 |
| Business expenses | Not deductible (TCJA 2018-2025) | Deductible on Schedule C |
| 475(f) MTM election | Not available | Available (converts to ordinary income) |
| Loss limitations | $3,000 cap on capital losses | $3,000 cap (unless 475(f) elected) |
| Self-employment tax | No | Generally no (capital gains nature) |
⚠ TTS + 475(f) = Loss of Section 1256 Treatment
If you qualify for Trader Tax Status (TTS) and make a Section 475(f) mark-to-market election, your Section 1256 contracts are converted to ordinary income treatment. You lose the beneficial 60/40 split but gain unlimited loss deductions.
Which Status Is Better?
The answer depends on your trading results:
📈 Profitable Traders
Keep Section 1256 treatment. Don't elect 475(f) - the 60/40 split gives you lower tax rates than ordinary income. TTS allows business expense deductions.
📉 Loss-Making Traders
Consider 475(f) election. Converting to ordinary losses allows unlimited deductions against W-2 income, instead of $3,000 capital loss limitation.
Cryptocurrency Futures and Section 1256
The tax treatment of cryptocurrency derivatives is evolving. Here's the current landscape:
Qualified for Section 1256
- CME Bitcoin futures (/BTC): Regulated futures contracts that qualify for Section 1256 treatment
- CME Ethereum futures (/ETH): Also qualify as regulated futures contracts
- Other exchange-traded crypto futures: Generally qualify if traded on CFTC-regulated exchanges
NOT Section 1256
- Spot cryptocurrency (BTC, ETH purchased on Coinbase, Kraken): Treated as property under IRS Notice 2014-21
- Perpetual swaps (common on Binance, BitMEX): Not regulated futures, likely ordinary gain/loss or capital gains
- Crypto options (Deribit, LedgerX): Tax treatment unclear; likely NOT Section 1256
- DeFi derivatives: Not regulated, no Section 1256 treatment
⚠ IRS Scrutiny
Cryptocurrency tax reporting is an IRS enforcement priority. In 2025, the IRS added a crypto question to the first page of Form 1040. Ensure you're reporting all crypto transactions, including futures. Misreporting can result in penalties and interest.
Planning for Crypto Traders
| Trading Activity | Tax Treatment | Reporting |
|---|---|---|
| CME Bitcoin/Ethereum futures | Section 1256 (60/40) | Form 6781, Schedule D |
| Spot crypto trading | Capital gains (actual holding period) | Form 8949, Schedule D |
| Perpetual swaps (offshore) | Capital gains or ordinary (unclear) | Form 8949 or Schedule C (consult CPA) |
| Staking, mining rewards | Ordinary income on receipt | Schedule 1, Schedule C (if business) |
💡 Tax Optimization Strategy
If you trade both spot crypto and crypto futures, consider concentrating profitable trades in CME futures (to get 60/40 treatment) and using spot crypto for loss harvesting (to preserve long-term capital loss treatment).
Contract Classification Quick Reference
Use this table to quickly determine if a contract qualifies for Section 1256 treatment:
| Contract Type | Examples | Section 1256? | Tax Treatment |
|---|---|---|---|
| Equity index futures | /ES, /NQ, /YM, /RTY | YES | 60/40, MTM required |
| Commodity futures | /CL, /GC, /NG, /ZW | YES | 60/40, MTM required |
| Interest rate futures | /ZN, /ZB, /GE | YES | 60/40, MTM required |
| Currency futures | /6E, /6J, /6B | YES | 60/40, MTM required |
| Crypto futures (CME) | /BTC, /ETH (CME only) | YES | 60/40, MTM required |
| Broad index options | SPX, VIX, RUT, NDX | YES | 60/40, MTM required |
| Options on futures | /ES options, /GC options | YES | 60/40, MTM required |
| ETF options | SPY, QQQ, IWM options | NO | Capital gains (actual period) |
| Equity options | AAPL, MSFT, GOOGL options | NO | Capital gains (actual period) |
| Spot forex (retail) | FXCM, OANDA, etc. | NO | IRC 988 ordinary (default) |
| Spot crypto | BTC, ETH on Coinbase | NO | Capital gains (property) |
| Crypto perpetual swaps | Binance, Bybit perps | NO | Unclear (likely capital gains) |
Tax Planning Strategies
1. Year-End Position Management
Since Section 1256 contracts are marked-to-market on Dec 31, consider:
- Close losing positions before year-end to accelerate loss recognition (though they'd be recognized anyway via MTM)
- Hold winning positions into January if you want to defer tax - but note that MTM will tax unrealized gains on Dec 31 regardless
- Ensure sufficient cash for tax payments on unrealized gains
2. Mixing Section 1256 with Other Strategies
- Use Section 1256 futures instead of ETFs when possible for better tax treatment (e.g., /ES futures vs SPY)
- Trade SPX options instead of SPY options for 60/40 treatment
- Harvest losses in non-1256 positions to offset 1256 gains, if you're in the 40% short-term portion
3. Loss Carryback Strategies
- Track your 3-year Section 1256 gain history to know your carryback potential
- File Form 1045 quickly after year-end to get refunds within 90 days
- Consider timing large losses to maximize carryback value
4. 475(f) Election Decision Tree
- If consistently profitable: Keep Section 1256 treatment, don't elect 475(f)
- If consistently losing: Consider 475(f) to deduct full losses against ordinary income
- If volatile year-to-year: Keep 1256 for carryback flexibility
Common Mistakes to Avoid
❌ Not Filing Form 6781
Some traders forget to file Form 6781 and only report on Schedule D. This can trigger IRS notices and delay refunds.
❌ Confusing SPX with SPY
SPX options get 60/40 treatment; SPY options don't. Using the wrong symbol can cost thousands in extra taxes.
❌ Ignoring MTM Unrealized Gains
Failing to account for year-end MTM can result in underpayment penalties and surprise tax bills.
❌ Making 475(f) Election Without Planning
Electing 475(f) is hard to reverse and converts beneficial 60/40 treatment to ordinary income. Analyze carefully first.
Additional Resources
- IRS Publication 550: Investment Income and Expenses (Chapter 4 covers Section 1256)
- Form 6781 Instructions: Official IRS guidance on reporting
- Green's Trader Tax Guide: Comprehensive annual guide for active traders
- Related guide: Section 475(f) Mark-to-Market Election