How Are Futures Taxed? The 60/40 Rule Explained

Futures contracts represent agreements to buy or sell an asset at a predetermined price on a future date. These standardized agreements are traded on regulated exchanges, serving for hedging against price fluctuations and for speculation on future price movements. Understanding the specific tax treatment of these instruments is important, as their taxation differs significantly from that of traditional securities like stocks. This unique tax framework aims to streamline reporting and provide certain advantages to futures traders.

Core Tax Principles for Futures Contracts

The taxation of futures contracts is governed by Section 1256 of the Internal Revenue Code. A Section 1256 contract encompasses regulated futures contracts, foreign currency contracts, non-equity options, dealer equity options, and dealer securities futures contracts. These instruments receive preferential tax treatment.

The “mark-to-market” rule mandates that all open Section 1256 contracts held at the end of the tax year must be treated as if they were sold at their fair market value on that date, regardless of whether they were actually closed. Any unrealized gains or losses resulting from this hypothetical sale are recognized for tax purposes in that year. This annual valuation ensures consistent accounting and prevents income deferral.

The “60/40 rule” dictates that capital gains or losses from these contracts are treated as 60% long-term and 40% short-term. This proportional split applies regardless of the holding period, bypassing the typical one-year requirement for long-term capital gains. For example, a $10,000 net gain results in $6,000 long-term and $4,000 short-term capital gain.

The 60/40 rule offers a significant tax advantage. Since 60% of gains are taxed at lower long-term capital gains rates, the effective tax rate on futures profits can be reduced compared to assets taxed at ordinary income or short-term rates. This simplifies tax planning for futures traders, providing predictability regardless of trading frequency or holding duration.

Reporting Futures Gains and Losses

Taxpayers report gains and losses from Section 1256 contracts to the Internal Revenue Service (IRS) using Form 6781, “Gains and Losses From Section 1256 Contracts and Straddles.” This form captures the tax treatment for these contracts, including mark-to-market adjustments.

On Form 6781, taxpayers report their aggregate net gain or loss from all Section 1256 contracts for the tax year. This includes realized gains and losses from closed contracts and unrealized gains and losses from open contracts due to the mark-to-market rule. After calculating the net amount, the form automatically applies the 60/40 split, with 40% as short-term and 60% as long-term capital gain or loss.

The 60/40 split from Form 6781 transfers to Schedule D, “Capital Gains and Losses,” of Form 1040. The short-term portion combines with other short-term capital gains and losses, and the long-term portion with other long-term capital gains and losses. This reflects the preferential tax treatment for Section 1256 contracts in the overall capital gains and losses calculation.

Brokerage firms provide necessary documentation, including Form 1099-B, “Proceeds From Broker and Barter Exchange Transactions,” which summarizes aggregate profit or loss from regulated futures contracts. This information is essential for accurately completing Form 6781 and Schedule D.

Special Rules and Exceptions

While most futures contracts fall under Section 1256, some do not. Non-Section 1256 contracts are generally treated as capital assets subject to standard capital gains and losses rules. Their taxation depends on the holding period: gains or losses from contracts held for one year or less are short-term, taxed at ordinary income rates, while those held for more than one year are long-term, taxed at preferential rates.

Hedging transactions have different rules. If a futures contract is a legitimate hedge to manage business risks, any gain or loss may be treated as ordinary income or loss, not capital. To qualify, the transaction must be clearly identified as a hedge by the taxpayer before the close of the day it was entered into, and meet specific IRS requirements for risk management. This allows businesses to match the character of gains and losses with the hedged income or expense.

Taxpayers with “mixed straddles” (at least one Section 1256 contract and one non-Section 1256 position) may elect out of the mark-to-market rules for the Section 1256 contracts within the straddle. This election, once made, applies for the current and all subsequent tax years unless the IRS grants consent for revocation. Such elections align the tax treatment of all straddle components.