How to Report Section 1256 Contracts From Your 1099-B

Many investors first encounter “Section 1256 contracts” while reviewing their Form 1099-B from a broker. These financial instruments have specific tax implications that can seem complex. Understanding what these contracts are, how they are presented on brokerage statements, and the process for correctly reporting them on a tax return is important for accurate filing.

Understanding Section 1256 Contracts

A Section 1256 contract is a specific type of investment defined by the Internal Revenue Code. Common examples include regulated futures contracts, foreign currency contracts, and non-equity options, such as those based on a commodity or a broad-based stock index. The tax code treats these contracts differently from other investments through two primary rules.

The first is the mark-to-market rule. This rule requires that any open Section 1256 contract held at year-end is treated as if it were sold at its fair market value on the last business day of that year. This means you must recognize gains or losses annually, even if they are unrealized. This prevents the deferral of gains or losses into future tax years.

The second treatment is the 60/40 rule. Regardless of how long you held the contract, any resulting capital gain or loss is considered 60% long-term and 40% short-term. This can be advantageous, as long-term capital gains are taxed at lower rates than short-term gains. This blended rate applies whether you held the contract for a day or for several months.

Locating Section 1256 Information on Form 1099-B

Your broker reports activity from Section 1256 contracts on Form 1099-B, “Proceeds From Broker and Barter Exchange Transactions.” Unlike stock transactions, which are reported individually, Section 1256 contract transactions are reported on an aggregate basis. The information is found in Boxes 8 through 11.

Box 8 shows the “Profit or (Loss) Realized” on contracts closed during the tax year. Box 9 reports the “Unrealized Profit or (Loss)” on open contracts as of the end of the previous year. Box 10 contains the “Unrealized Profit or (Loss)” on your open contracts as of the end of the current tax year.

These three figures are combined to calculate the “Aggregate Profit or (Loss)” shown in Box 11. This final number represents your total reportable gain or loss for the year from all your Section 1256 contract activities.

Reporting on Form 6781

The aggregate profit or loss from Box 11 of Form 1099-B is reported on Form 6781, “Gains and Losses From Section 1256 Contracts and Straddles.” You will work with Part I, titled “Section 1256 Contracts Marked to Market.”

Enter the aggregate profit or loss from Box 11 onto line 1 of Form 6781. If the amount is a gain, you enter it in column (c); if it is a loss, it goes in column (b). After summing the columns on line 2, you will combine them on line 3 to show your net gain or loss.

Assuming no other adjustments, this net figure carries down to line 7. You will multiply the amount on line 7 by 40% (0.40) and enter the result on line 8 as your short-term capital gain or loss. You then multiply the line 7 amount by 60% (0.60) and enter that result on line 9 as your long-term capital gain or loss.

Transferring Results to Schedule D

After completing Part I of Form 6781, the final step is to transfer the calculated gains or losses to Schedule D, “Capital Gains and Losses.” This integrates your Section 1256 contract results with any other capital gains and losses you may have for the year.

The short-term capital gain or loss from line 8 of Form 6781 is carried over to line 4 of Schedule D. The long-term capital gain or loss from line 9 of Form 6781 is reported on line 11 of Schedule D. These entries are then combined with other short-term and long-term transactions to determine your total net capital gain or loss for the year.

Special Rules for Losses

If your net result from Section 1256 contracts is a loss, a special rule allows taxpayers to carry back a net Section 1256 contract loss for three years. This allows you to offset gains from Section 1256 contracts reported in those prior years, potentially resulting in a tax refund. The loss must be carried back to the earliest year first.

To make this election, you must check box D on Form 6781 and enter the amount of the loss you intend to carry back on line 6. The carryback is claimed by filing an amended return, Form 1040-X, for the prior year to which you are carrying the loss. You must attach a revised Form 6781 and a revised Schedule D for that prior year.

The amount of loss you can carry back to a prior year is limited. It cannot exceed the net Section 1256 contract gain in that year, and it cannot be used to create or increase a net operating loss for that carryback year. This provision is only available to individual taxpayers; corporations and partnerships are not eligible.