Forex 60/40 Rule (Section 1256)
Overview
Section 1256 of the US Internal Revenue Code provides a significant tax advantage for certain forex contracts: gains and losses are treated as 60% long-term and 40% short-term capital gains, regardless of actual holding period. This applies to regulated futures contracts (RFC) and foreign currency contracts traded on regulated exchanges. The blended rate is typically lower than short-term rates, benefiting active traders.
Key Points
60% of gains taxed at long-term rate (max 20%), 40% at short-term rate (max 37%), Applies to: regulated futures, broad-based index options, certain forex contracts, Mark-to-market: 1256 contracts are marked to market at year-end, Loss carryback: 1256 losses can be carried back 3 years (unique advantage), Spot forex: may elect Section 1256 treatment via opt-out of Section 988, Forex forwards and OTC options: generally fall under Section 988 instead
Tax Rates
Blended rate: ~23% maximum (60% × 20% + 40% × 37%). Compare to 37% maximum for pure short-term gains. At the highest bracket, this saves 14 percentage points.
Reporting Requirements
Form 6781: Gains and Losses from Section 1256 Contracts and Straddles. Year-end mark-to-market required. Document your Section 988 opt-out election if applicable for spot forex. Keep broker 1099-B statements.
Tips & Recommendations
The 60/40 rule is one of the best tax advantages available to active traders. If you trade forex, understand whether your contracts qualify under Section 1256 or Section 988. Consider filing the election to opt out of Section 988 for spot forex if 1256 treatment is more favorable. The 3-year loss carryback provision is unique and extremely valuable in losing years.
Disclaimer: This guide is for informational purposes only and does not constitute tax advice. Tax laws change frequently. Always consult a qualified tax professional for advice specific to your situation.
Related Tax Guides
Section 988 vs Section 1256
Forex traders in the US must choose between Section 988 (default for spot forex) and Section 1256 (elective for certain contracts). Section 988 treats gains as ordinary income but allows unlimited loss deductions against other income. Section 1256 provides the favorable 60/40 split but limits losses to the $3,000 annual cap against ordinary income. The right choice depends on whether you're profitable or running losses.
Wash Sale Rules for Stocks
The wash sale rule (IRS Section 1091) prevents US stock and securities traders from claiming a tax loss if they repurchase a 'substantially identical' security within 30 days before or after the loss sale (61-day window). The disallowed loss is added to the cost basis of the replacement shares. This rule applies to stocks, bonds, options, and ETFs but does NOT (as of 2024) apply to cryptocurrency.
Spread Betting Tax (UK)
Spread betting in the UK is classified as gambling by HMRC, making profits completely tax-free — no income tax, no capital gains tax. This is one of the biggest tax advantages available to UK-based traders. However, losses are also not deductible. Spread betting is only available to UK and Ireland residents through FCA-regulated providers. It covers forex, stocks, indices, commodities, and crypto.
Trader vs Investor Tax Status
The IRS distinguishes between investors, active traders, and dealer/day traders — each with dramatically different tax treatment. Investors get capital gains rates but can only deduct $3,000 in losses against ordinary income. Traders who qualify for 'trader tax status' (TTS) can deduct all business expenses, mark-to-market elect (Section 475), and avoid wash sale rules. The distinction hinges on frequency, holding period, and intent.