Section 1256 Contracts (60/40 Rule)

Detailed Explanation

Section 1256 contracts include regulated futures contracts, foreign currency contracts, nonequity options (such as broad-based stock index options), dealer equity options, and dealer securities futures contracts. The statute requires them to be marked to market at year-end: each contract held at the close of the year is treated as sold at fair market value, so gains and losses are recognized annually whether or not the position is closed. The signature benefit is the 60/40 rule: regardless of how long the contract was actually held, 60% of the gain or loss is treated as long-term and 40% as short-term, producing a blended top rate well below the ordinary rate. These are reported on Form 6781 and flow to Schedule D. For an active trader, Section 1256 contracts interact carefully with the Section 475(f) election: the securities election does not automatically sweep in Section 1256 contracts, and a trader generally should not elect mark-to-market for them, because doing so would convert the favorable 60/40 treatment into fully ordinary income. The commodities election under Section 475(f)(2) is separate from the securities election under 475(f)(1).