Futures and index-option traders run into a tax rule that most stock traders never have to think about, and it cuts both ways. A position held for eleven minutes can qualify for a blended rate close to the long-term capital gains rate, while a nearly identical-looking trade one strike over on an ETF option gets no such benefit at all. Section 1256 of the tax code is one of the more taxpayer-friendly corners of the code, but it is also one of the most misunderstood, and the line it draws between similar-looking contracts trips up traders every year.
What is a Section 1256 contract?
A Section 1256 contract is not a general category, it is a specific statutory list under IRC section 1256(b)(1) of five instrument types that Congress decided should be marked to market every year instead of taxed only when closed. The list covers regulated futures contracts, foreign currency contracts, non-equity options (the category that captures broad-based index options like SPX), dealer equity options, and dealer securities futures contracts.
The Five Section 1256 Contract Categories
Reference- Regulated futures contracts. Futures traded on a qualified board or exchange, such as commodity, currency, and stock index futures on the CME and similar exchanges, where the broker marks positions to market daily under exchange rules.
- Foreign currency contracts. Interbank-market forward contracts in major currencies, not the retail spot forex market. Exchange-traded currency futures already qualify separately as regulated futures contracts.
- Non-equity options. Options on something other than a single stock. The most common example is a broad-based, cash-settled stock index option such as SPX (S&P 500), NDX (Nasdaq-100), RUT (Russell 2000), XSP (Mini-SPX), or VIX, but the category also covers options on a qualified-exchange commodity future.
- Dealer equity options. Options written by an options dealer in that dealer capacity, a narrow category that mostly affects market makers rather than retail traders.
- Dealer securities futures contracts. Securities futures written by a dealer in that dealer capacity, the least common of the five and again mostly relevant to market makers.
For an active trader, the two categories that come up constantly are regulated futures and non-equity options in the form of broad-based index options. Only a broad-based index option qualifies; a narrow-based index option, one built from a small number of components or a single industry sector, is taxed as an ordinary equity option with no 60/40 benefit. Both regulated futures and broad-based index options are marked to market by the exchange or the broker's own accounting mechanics before the tax rule even applies, which is part of why Congress chose them for special treatment.
What is the 60/40 rule for Section 1256 contracts?
The 60/40 rule assigns 60% of a Section 1256 contract's total gain or loss for the year to the long-term capital gains rate and 40% to the short-term rate, and it applies to every contract regardless of how long you actually held it. A futures contract opened and closed within the same minute gets exactly the same 60/40 split as one held for eleven months.
That split matters because of the rate gap it closes. Ordinary short-term gains and equity-option gains are taxed at up to 37% at the top bracket, while long-term capital gains top out at 20%. Blending 60% at 20% with 40% at 37% produces a combined top rate of about 26.8%, a meaningful discount from paying the full ordinary rate on every dollar. That 26.8% figure is before the 3.8% net investment income tax that can apply to high-income traders and before any state income tax, both of which sit on top of the federal blend.
The mechanics run through year-end mark-to-market by statute: every Section 1256 position still open on the last business day of the tax year is treated as sold at its fair market value that day, and the resulting gain or loss is recognized in the current year even though the contract was never actually closed. When the position is eventually closed for real, in the following year, the basis is adjusted for the amount already recognized so the same gain is not taxed twice. All of it, the deemed year-end gains and the gains on contracts actually closed during the year, is reported on Form 6781 and carried from there onto Schedule D with the 60/40 split already applied. Because open positions are marked to market at year end, a trader can owe tax in April on unrealized gains on positions still open at December 31, even if those positions later reverse, so it is worth reserving cash for that liability rather than assuming only realized profits are taxable.
Are SPX and other broad-based index options taxed the same as SPY options?
No, and this is a common source of confusion for index traders. SPX, NDX, RUT, XSP, and VIX options are broad-based index options that settle in cash against the index itself, which puts them squarely inside the Section 1256 definition and gives them 60/40 treatment. SPY, QQQ, and IWM options look like they track the same markets, but they are options on an exchange-traded fund's shares, which makes them ordinary equity options taxed under the standard short-term or long-term capital gains rules, with no 60/40 benefit at all.
The economic exposure can be nearly identical, an SPX call and a similarly structured SPY call both move with the S&P 500, but the tax result is not. A trader who closes both positions the same day pays up to 37% on the SPY gain and roughly 26.8% at the top bracket (lower in lower brackets) on the SPX gain, on top of the fact that SPX contracts have a larger notional size and settle in cash rather than shares, which changes position sizing too.
Brokers generally code this correctly on the 1099-B, with Section 1256 contracts broken out in their own section showing the 60/40 split, but it is worth checking every year, especially if you trade both index and ETF options in the same account.
Do wash sale rules apply to futures and index options?
No. Section 1256 contracts are exempt from the wash sale rule because the year-end mark-to-market mechanism already forces recognition of gains and losses on schedule, so there is no deferred loss for a wash sale rule to protect against. You can close a losing futures position and reopen a similar one the next day without any loss disallowance or basis adjustment.
That is a structural advantage over trading the same market exposure through ETF options or the underlying shares, where a loss followed by a repurchase of a substantially identical position within 30 days on either side triggers the wash sale rule and defers the loss into the replacement position's basis instead of allowing it currently. Our wash sale rule guide covers how that disallowance works and how it can quietly erase deductions for equity and ETF-option traders who do not track it carefully. A trader who splits activity between SPX and SPY, for example, only has to watch for wash sales on the SPY side.
Can you carry back a Section 1256 loss?
Yes. A non-corporate taxpayer, meaning an individual or most pass-through entity owners, who has a net loss for the year on Section 1256 contracts can elect to carry that loss back three tax years instead of only carrying it forward. The catch is that the carryback only offsets Section 1256 gains reported in those specific prior years, not ordinary income or other capital gains, and it preserves the 60/40 character when it is applied. In practice that means the election helps most when you had a strong Section 1256 gain year within the prior three years and a loss year now, letting you recover tax already paid on that earlier gain.
Making the election means amending the return for the earliest carryback year first and working forward, generally by filing an amended Form 6781 with an amended return or a Form 1045 application for a quick refund, and the loss must be applied to the earliest available year before any remainder moves to the next one. If you skip the election or do not have Section 1256 gains in the lookback window to absorb the loss, the net Section 1256 loss simply carries forward like an ordinary capital loss, subject to the usual $3,000 annual limit against other income for anything not absorbed by future capital gains.
How are spot and forex trading taxed under Section 988?
Retail spot and forward foreign currency trading generally falls under Section 988 rather than Section 1256, and the default treatment there is the opposite of favorable: gains and losses are ordinary, taxed at your regular rate with no 60/40 split and no long-term rate available. Losses are at least fully deductible against ordinary income without the $3,000 capital loss cap. A trader can elect out of Section 988 treatment, but that election does not open the door to long-term rates. What it does is make gains and losses capital rather than ordinary. For a contract that itself qualifies as a Section 1256 contract, such as an interbank major-currency forward, that capital treatment is the 60/40 blend, but for retail spot forex held short-term it is simply a short-term capital gain taxed at the same top ordinary rate, so electing out often produces no rate cut at all. The clean election out of Section 988 is generally available for interbank major-currency forward contracts; its application to ordinary retail spot forex is unsettled, so confirm eligibility with your broker's tax documentation before relying on it. Whatever the underlying contract, the election itself has to be made and documented before the trades occur, not after seeing the year's results.
Major-currency forward contracts that trade in the interbank market can qualify as Section 1256 foreign currency contracts rather than Section 988 contracts. This is why the definition above centers on interbank-active major currencies rather than any forex trade generally. Retail spot forex and contracts for difference, commonly called CFDs, are generally not Section 1256 contracts and typically fall under Section 988 or are simply unavailable to US retail traders in the first place. Because the line between Section 988 and Section 1256 for currency contracts depends on exactly how and where the contract trades, it is worth confirming the classification with your broker's tax documentation rather than assuming based on the currency alone.
Does the Section 475(f) election apply to futures and index options?
Not by itself. A securities trader who qualifies for trader tax status and makes the Section 475(f) election is electing mark-to-market treatment under Section 475(f)(1), which applies to securities. That election does not automatically extend to regulated futures or broad-based index options, because pulling Section 1256 contracts into mark-to-market ordinary treatment requires a separate election under Section 475(f)(2) for commodities.
Most traders who qualify for and use the securities 475 election deliberately do not make the parallel commodities election, because doing so would convert their Section 1256 gains from the 60/40 blend into fully ordinary income, giving up the rate advantage entirely. The two elections, their deadlines, and the mechanics of Form 3115 and the built-in Section 481(a) adjustment that comes with either one are covered in full in our guide to trader tax status and the mark-to-market election. If you trade both securities and futures, the two elections need to be evaluated separately rather than assumed to move together.
Bottom Line
Section 1256 status turns on the specific instrument, not on how the trade feels or what it tracks, and the SPX-versus-SPY distinction alone is worth real money to an active index trader every year. The 60/40 blend, the exemption from wash sales, and the three-year loss carryback are genuine advantages built into the statute, but each one has a precise mechanical requirement, correct identification on Form 6781, an election filed in the right order for a carryback, and a separate commodities election if you want mark-to-market ordinary treatment instead. Getting the classification and the elections right is where the value actually gets captured.
Have questions about Section 1256 contracts or how futures and index-option trading fits your overall tax picture? Contact TS CPA for a free consultation. We respond within the same day.