A section 1256 contract is a regulated futures contract, foreign currency contract, non-equity option or dealer securities contract typically reported to taxpayers in Box 10,11 and 12 on Form 1099-B.
In general, gain and loss recognition does not occur until the investment is sold, however, the gains and losses from Section 1256 contracts are "marked-to-market", which means that any contract held at the end of the tax year is assumed to have been sold for its current fair market value. The resulting unrealized gain or loss is recognized. When the contract is actually sold, any difference between the actual gain or loss realized on the sale and any amounts of unrealized gain or loss that have previously been recognized is captured in the year of sale. Additionally, these transactions receive special gain/loss treatment for tax purposes. Section 1256 gains/losses are taxed as if the gain or loss is 40% short term and 60% long term capital gains.
Since these contracts are considered to be sold every year, the holding period of the underlying asset does not determine whether or not the gain or loss is short term or long term, rather all gains and losses on these contracts are considered to be 60% long term and 40% short term capital gain.
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Note
- 1256 option contracts have realized gains on an exercise or assignment. The gain is computed by marking the original option trade to the closing price on the Trade Date of the Exercise or Assignment transaction.