What Is a Section 1256 Gain and How Is It Taxed?

A Section 1256 gain is a profit on certain exchange-traded futures and options that federal tax law treats as 60 percent long-term capital gain and 40 percent short-term capital gain, no matter how briefly you held the contract.¹ For a high-income trader, that blended split caps the federal rate on net gains at roughly 26.8 percent, well below the 37 percent top rate on ordinary short-term gains. There’s a catch on timing: every open position is treated as sold at fair market value on the last business day of the year, so you can’t defer a gain by holding a contract past December 31.

Which Contracts Produce Section 1256 Gains

The 60/40 treatment is limited to five categories of contracts traded on, or subject to the rules of, a qualified board or exchange:¹

Regulated futures contracts, such as crude oil futures or S&P 500 index futures on the Chicago Mercantile Exchange.
Foreign currency contracts settled through a qualified exchange.
Nonequity options, meaning options on broad-based stock indexes, commodities, or interest rates. SPX index options are the common example.
Dealer equity options, held by a registered options dealer in the normal course of business.
Dealer securities futures contracts, again limited to registered securities dealers.

A “qualified board or exchange” covers any national securities exchange registered with the SEC, any domestic board of trade designated as a contract market by the CFTC, and specific foreign exchanges approved by the Treasury Department, including ICE Futures Europe, Eurex Deutschland, and the Bourse de Montréal. A contract trading somewhere off that list does not get Section 1256 treatment.

What Does Not Qualify

Two categories cause the most confusion. Options on a single company’s stock, like a call on Apple or Tesla, are not Section 1256 contracts when a regular investor holds them. Those are equity options, and the 60/40 split is reserved for registered options dealers who acquire them in market-making.¹ Retail traders buying puts and calls on individual stocks fall under standard capital gains rules and need to hold more than a year for long-term treatment.²

Cryptocurrency contracts follow the same exchange-driven logic. Bitcoin futures and options on the CME qualify because the CME is a CFTC-designated contract market. Crypto contracts traded on unregulated or non-CFTC-designated platforms do not qualify. The venue matters as much as the underlying asset.

How the 60/40 Split Is Taxed

When you close a position or the year ends, your net gain or loss is split automatically: 60 percent long-term, 40 percent short-term.¹ Actual holding period is irrelevant. A contract you held for three days gets the same split as one you held for three months.

Long-term capital gains top out at a federal rate of 20 percent, and short-term gains are taxed as ordinary income up to 37 percent.² Running the arithmetic:

60% × 20% = 12.0% on the long-term portion
40% × 37% = 14.8% on the short-term portion
Combined maximum: 26.8%

That’s more than 10 percentage points below what the same trading profits would cost under standard short-term rules. On $100,000 of net futures gains, the split saves a top-bracket trader roughly $10,200 in federal tax compared with pure ordinary income treatment.

Net Investment Income Tax

The 26.8 percent figure is the maximum from the regular income tax alone. High earners also owe an additional 3.8 percent net investment income tax on Section 1256 gains once modified adjusted gross income exceeds $200,000 for single filers or $250,000 for married couples filing jointly.³ Those thresholds are fixed in the statute and do not adjust for inflation. When the NIIT applies to the full gain, the true maximum federal rate on Section 1256 gains reaches about 30.6 percent, still below the 40.8 percent ceiling that ordinary short-term gains would face for the same taxpayers.

Year-End Mark-to-Market

Section 1256 does not allow you to defer a gain by keeping a contract open past December 31. Every contract still open at year-end is treated as if you sold it at fair market value on the last business day of the year, and the resulting gain or loss is recognized for that tax year.¹ Your broker reports the valuation on a year-end statement.

To prevent double-counting, the contract’s tax basis is adjusted at the start of the new year to reflect whatever gain or loss was already recognized. Recognize $5,000 of gain at year-end mark-to-market, and your basis in that contract goes up by $5,000 heading into January. When you eventually close the position, only the change beyond that amount is taxable.

Record-keeping gets simpler because you don’t need to track individual purchase dates and holding periods. Everything nets to a single annual calculation. The trade-off: you can owe tax on paper gains from positions you haven’t closed, which catches some traders off guard in years when markets rally into December.

How Section 1256 Losses Work

Losses get the same 60/40 characterization as gains, and they offset capital gains of the matching type on your return. If total capital losses exceed capital gains for the year, up to $3,000 of the net loss can offset ordinary income, and the rest carries forward under standard capital loss rules.

Three-Year Loss Carryback

Section 1256 traders get a recovery tool most other investors don’t have: a three-year carryback. If you have a net Section 1256 loss, you can elect to carry it back and apply it against net Section 1256 gains reported in any of the three preceding tax years.⁴ The 60/40 split carries through, and the carryback can only offset prior-year Section 1256 gains. It cannot reduce gains from stocks, real estate, or any other non-1256 source in those earlier years.

You claim the refund on Form 1045, Application for Tentative Refund, filed within one year after the end of the loss year.⁵ The IRS is required to process the application within 90 days. You also check box D on Form 6781 and enter the carryback loss amount there. The earliest prior year absorbs the loss first; any remainder rolls forward one year at a time.

Reporting Section 1256 Gains on Your Return

All Section 1256 gains and losses are reported on Form 6781, Gains and Losses From Section 1256 Contracts and Straddles.⁶ Your broker’s year-end statement, typically a Form 1099-B, provides the aggregate net gain or loss from mark-to-market and closed positions. That figure flows into Part I of Form 6781.

The form handles the split. Line 8 multiplies the net amount by 40 percent for the short-term portion, and Line 9 multiplies by 60 percent for the long-term portion.⁷ The short-term result on Line 8 transfers to Line 4 of Schedule D, and the long-term result on Line 9 goes to Line 11 of Schedule D. Schedule D combines these with your other capital gains and losses, and the bottom line flows to Form 1040.

Some commodity-based exchange-traded funds are structured as partnerships that hold futures contracts internally. Instead of a 1099-B, these funds issue a Schedule K-1 reporting your share of Section 1256 gains or losses. The same rules and the same Form 6781 apply.

Two Situations Where 60/40 Doesn’t Apply

A Section 1256 contract entered by a business primarily to reduce its exposure to price or currency changes tied to ordinary business income is a hedging transaction. Qualifying hedges receive ordinary income or loss treatment, not the 60/40 split.¹ The identification requirement is strict: you must designate the contract as a hedge before the close of the day you enter it. Retroactive identification is not allowed.

Foreign currency contracts sit between two rules. Section 988 generally treats currency gains and losses as ordinary income, but qualifying regulated futures and nonequity options are carved out of Section 988 by default and land in Section 1256’s 60/40 regime.⁸ You can elect out and back into ordinary treatment, but the election must be made on or before the first day of the tax year, or on or before the first day during the year you hold a qualifying contract, whichever is later. Once made, the election applies to all such contracts for that year and every year after unless the IRS consents to revoke it.

1
Office of the Law Revision Counsel. 26 USC 1256 – Section 1256 Contracts Marked to Market
2
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
3
Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax
4
Office of the Law Revision Counsel. 26 USC 1212 – Capital Loss Carrybacks and Carryovers
5
Internal Revenue Service. Instructions for Form 1045
6
Internal Revenue Service. About Form 6781, Gains and Losses From Section 1256 Contracts and Straddles
7
Internal Revenue Service. Form 6781 – Gains and Losses From Section 1256 Contracts and Straddles
8
Office of the Law Revision Counsel. 26 US Code 988 – Treatment of Certain Foreign Currency Transactions