Confused about forex trading tax treatment - Section 988 vs 1256?

Started trading forex this year on OANDA (spot forex). Made about $18K in gains so far. Now doing my research on taxes and I'm completely lost.

I keep seeing two different tax sections mentioned - 988 and 1256. What's the difference? Which one applies to me? And I've heard something about making an "election" but have no idea what that means or how to do it.

Help please!

Good question. This trips up a lot of forex traders.

Section 988 is the default for spot forex. It treats your gains/losses as ordinary income/loss - same tax rate as your salary. So if you're in the 24% bracket, your $18K gets taxed at 24%.

Section 1256 applies to regulated futures contracts and certain options. This gives you the 60/40 rule: 60% taxed at long-term capital gains rate (15-20%), 40% at short-term. Usually more favorable.

Spot forex defaults to 988, but you can opt out and treat it as 1256 by making an internal election.

Wait, so I can just choose whichever one is better for me? That seems... too easy?

Not quite that simple. The election has to be made BEFORE you start trading for the year - it needs to be an "internal notation" in your books before January 1st (or before your first trade if you start mid-year).

If you've already been trading in 2025 and didn't make the election, you're stuck with Section 988 for this year. You can make the election for 2026 though.

Also important: if you trade forex futures (like /6E on CME), those automatically get 1256 treatment. No election needed. Only spot forex requires the opt-out election.

I made this mistake my first year. Didn't know about the election, got hit with ordinary income rates on $40K. Hurt.

Now I trade /6E futures instead of spot. Automatic 1256 treatment, plus the leverage and liquidity are actually better than most retail spot brokers.

Ugh, so I'm stuck with 988 for this year. That's frustrating. How exactly do I make the election for next year? Is there a specific form I file with the IRS?

No IRS form. It's an "internal election" which means you just need to document it in your own books/records. Create a simple written statement like:

"I, [Your Name], elect to opt out of IRC Section 988 treatment for all spot forex transactions, effective January 1, 2026."

Date it, sign it, keep it with your tax records. That's it. Then report your forex gains/losses on Form 6781 instead of treating them as ordinary income.

Pro tip: make this election before your first trade of 2026. If you wait until after, it doesn't count.

One thing to consider: Section 988 does have one advantage - you can deduct losses as ordinary losses without the $3,000 capital loss limitation.

If you have a losing year (and let's be real, most retail traders do), 988 lets you deduct the full loss against your ordinary income. With 1256/capital treatment, you're capped at $3K per year with the rest carried forward.

So it's not always better to opt out of 988. Depends on whether you're consistently profitable.

Excellent point from @PropTrader_Kyle. To summarize the tradeoffs:

Section 988 (default):

• Gains taxed as ordinary income (10-37% depending on bracket)
• Losses fully deductible as ordinary losses (no $3K cap)
• No mark-to-market complications

Section 1256 (with opt-out election):

• 60/40 split (60% long-term, 40% short-term capital gains)
• Losses subject to capital loss limitations ($3K/year)
• Must report on Form 6781
• Generally better if consistently profitable

Also worth noting: if you're a full-time trader, you might qualify for mark-to-market election (IRC 475(f)), which is a whole different ball game.

Quick question on this - what if you trade both spot forex AND forex futures in the same account? Can you have different treatment for each, or do you have to pick one?

Good question. They're treated separately. Forex futures automatically get 1256 treatment regardless of your election. The 988 opt-out election only affects your spot forex positions.

So you could theoretically have spot forex under 988 and futures under 1256, or both under 1256 if you make the election. You just can't get futures under 988 - that's not an option.

Final note for @ForexNewbie23: whatever you decide for 2026, make sure you keep detailed trade records. Most forex brokers provide terrible tax reporting compared to stock brokers. You'll likely need to track everything yourself and calculate gains/losses manually.