Taxes (individual returns): Section 1256 Contracts, Equity Options, and Reporting Cap Gains/Losses
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Section 1256 Contracts and Marked to Market Rules:
A section 1256 contract is any:
1. Regulated futures contract,
2. Foreign currency contract,
3. NONequity option, OR
4. DEALER Equity option.
Regulated futures contract
This is a contract that:
Provides that amounts that must be deposited to, or can be withdrawn from, your margin account depend on daily market conditions (a system of marking to market), and
Is traded on, or subject to the rules of, a qualified board of exchange.
A qualified board of exchange is a domestic board of trade designated as a contract market by the Commodity Futures Trading Commission, any board of trade or exchange approved by the Secretary of the Treasury, or a national securities exchange registered with the Securities and Exchange Commission.
Foreign currency contract
This is a contract that:
Requires delivery of a foreign currency that has positions traded through regulated futures contracts (or settlement of which depends on the value of that type of foreign currency),
Is traded in the interbank market, and
Is entered into at arm's length at a price determined by reference to the price in the interbank market.
NONequity Options
Nonequity options include debt options, commodity futures options, currency options, and broad-based stock index options. A broad-based stock index is based upon the value of a group of diversified stocks or securities (such as the Standard and Poor's 500 index).
Warrants based on a stock index that are economically, substantially identical in all material respects to options based on a stock index are treated as options based on a stock index.
DEALER Equity Option
This is any listed option that, for an options dealer:
Is an equity option,
Is bought or granted by that dealer in the normal course of the dealer's business activity of dealing in options, and
Is listed on the qualified board of exchange where that dealer is registered.
An options dealer is any person registered with an appropriate national securities exchange as a market maker or specialist in listed options.
Marked to Market Rules:
A section 1256 contract that you hold at the end of the tax year will generally be treated as sold at its fair market value on the last business day of the tax year, and you must recognize any gain or loss that results. When you later dispose of the contract, any gain or loss is considered in figuring the gain or loss from the disposition, as shown in the example under 60/40 rule, below.
Hedging exception. The marked to market rules do NOT apply to hedging transactions.
60/40 Rule:
Under the marked to market system, 60% of your capital gain or loss will be treated as a long-term capital gain or loss, and 40% will be treated as a short-term capital gain or loss. This is true regardless of how long you actually held the property.
Example:
On June 23, 1998, you bought a regulated futures contract for $50,000. On December 31, 1998 (the last business day of your tax year), the fair market value of the contract was $57,000. You have a $7,000 gain recognized on your 1998 tax return, treated as 60% long-term and 40% short-term capital gain.
On February 2, 1999, you sold the contract for $56,000. Because you already recognized a $7,000 gain on your 1998 return, you recognize a $1,000 loss ($57,000 - $56,000) on your 1999 tax return, treated as 60% long-term and 40% short-term capital loss.
How to Report:
If you disposed of regulated futures or foreign currency contracts in 1999 (or had unrealized profit or loss on these contracts that were open at the end of 1998 or 1999), you should receive Form 1099-B, or an equivalent statement, from your broker.
Form 6781
Use Form 6781 to report gains and losses from section 1256 contracts and straddles before entering these amounts on Schedule D. Include a copy of Form 6781 with your income tax return.
Loss Carryback Election:
An individual or partnership having a net section 1256 contracts loss for 1999 can elect to carry this loss back 3 years, instead of carrying it over to the next year.
To carry back your loss, file an amended Form 6781 for the year to which you are carrying the loss, together with Form 1040X or appropriate amended return. Follow the instructions for completing Form 6781 for the loss year to make this election.
irs.ustreas.gov
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Equity Options:
Equity option. This is any option:
1. To buy or sell stock, or
2. That is valued directly or indirectly by reference to any stock, group of stocks, OR stock index.
Equity options include options on certain narrow-based stock indexes, but EXCLUDE options on broad-based stock indexes and options on stock index futures.
If the option is part of a straddle, the loss deferral rules covered later under Straddles may also apply.
Gain or loss from the sale or trade of an option to buy or sell property that is a capital asset in your hands, or would be if you acquired it, is capital gain or loss. If the property is not, or would not be, a capital asset, the gain or loss is ordinary gain or loss.
Option not exercised
If you do not exercise an option to buy or sell, and you have a loss, you are considered to have sold or traded the option on the date that it expired.
Writer of option
If you write (grant) an option, how you report your gain or loss depends on whether it was exercised.
If you are NOT in the business of writing options and an option you write on stocks, securities, commodities, or commodity futures is not exercised, the amount you receive is a short-term capital gain.
How to Report:
Gain or loss from the closing or expiration of an option that is not a section 1256 contract, but that is a capital asset in your hands, is reported on Schedule D (Form 1040).
If an option you purchased expired, enter the expiration date in column (c) and write "Expired" in column (d).
If an option that you wrote expired, enter the expiration date in column (b) and write "Expired" in column (e).
irs.ustreas.gov
irs.ustreas.gov
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Stradles:
Details in the link below:
irs.ustreas.gov
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Reporting Capital Gains and Losses (GENERAL):
irs.ustreas.gov
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