What Are the Tax Benefits of Futures Trading?

Futures contracts are financial agreements to buy or sell an asset at a predetermined price on a future date. Their treatment under U.S. tax law is distinct from other investments like stocks, as the Internal Revenue Service (IRS) has specific rules for them. These regulations govern how gains and losses from futures are calculated, reported, and taxed.

The 60/40 Rule for Section 1256 Contracts

The tax benefits of futures trading are linked to their classification as “Section 1256 contracts” by the IRS. This category includes regulated futures, foreign currency contracts, and certain options like non-equity and broad-based stock index options. These instruments are subject to a “mark-to-market” accounting system, where every open contract is treated as if it were sold at its fair market value on the last business day of the tax year. This means both realized and unrealized gains and losses must be reported annually.

This mark-to-market system leads to the application of the blended “60/40 rule.” Regardless of how long a futures position was held, all capital gains and losses are treated as 60% long-term and 40% short-term. This automatic allocation is advantageous because long-term capital gains are taxed at lower rates (0%, 15%, or 20%, depending on income) than short-term gains, which are taxed at ordinary income rates that can be as high as 37%.

For example, consider a trader who realizes a $10,000 net gain from futures trading. Applying the 60/40 rule, $6,000 of the gain is considered long-term, and the remaining $4,000 is short-term. If this trader is in the 24% tax bracket for ordinary income and the 15% bracket for long-term capital gains, their tax liability would be (15% of $6,000) + (24% of $4,000), which equals $900 + $960, for a total tax of $1,860.

This outcome contrasts with the tax treatment of a short-term stock trade. If the same trader had generated a $10,000 gain by holding a stock for less than a year, the entire amount would be taxed at their ordinary income rate of 24%, resulting in a tax of $2,400. The 60/40 rule, in this scenario, provides a tax savings of $540.

Absence of the Wash Sale Rule

Another tax distinction for futures traders is the inapplicability of the wash sale rule. The wash sale rule applies to securities like stocks and bonds, and it prevents a taxpayer from claiming a capital loss on a sale if they purchase a “substantially identical” security within 30 days before or after. This 61-day window is designed to stop investors from creating artificial losses for tax purposes.

However, the IRS exempts Section 1256 contracts from this rule. This exemption exists because the mark-to-market accounting system already requires all gains and losses to be recognized annually, making the concept of deferring a specific loss moot.

The absence of the wash sale rule gives traders more flexibility. For instance, a trader could sell a futures contract at a loss to realize that loss for tax purposes and then immediately re-enter the same position. With securities, this action would trigger the wash sale rule, and the loss would be disallowed for the current tax year. For a futures trader, the loss is recognized immediately and can offset other gains.

Tax Loss Carryback Provisions

Futures trading offers a mechanism for handling net losses that is not available for most other investments. When an individual has a net capital loss from securities, they can use it to offset gains and then deduct up to $3,000 of any excess loss against ordinary income per year. Any remaining loss is carried forward to future tax years.

Section 1256 contracts provide an alternative. If a trader has a net loss from futures for the year, they can elect to carry that loss back to the three preceding tax years. This is known as a net Section 1256 contracts loss carryback. The loss must be applied to the earliest of the three prior years first and can only be used to offset net Section 1256 gains from those years; it cannot reduce other income.

To use this provision, the trader must file an election with their tax return for the year of the loss, which often involves filing amended tax returns for the prior years. By amending a previous year’s return, a trader can receive a tax refund for taxes paid on gains in those profitable years. This provides an immediate tax benefit from a current-year loss.

Reporting Gains and Losses

After the tax year concludes, a trader will receive Form 1099-B from their brokerage firm. This document summarizes the trader’s financial activities, and for futures traders, the aggregate profit or loss from Section 1256 contracts is reported in Box 11.

This aggregate gain or loss figure is the starting point for tax reporting. The trader must use IRS Form 6781, Gains and Losses From Section 1256 Contracts and Straddles. The net gain or loss from Box 11 of the 1099-B is transferred to Part I of Form 6781.

Form 6781 handles the 60/40 split calculation. The form directs the filer to allocate 40% of the amount as a short-term capital gain or loss and 60% as a long-term capital gain or loss. These two figures are then transferred from Form 6781 to the appropriate lines on Schedule D (Form 1040), where they are combined with any other capital gains and losses.