Alright traders, let’s talk about one of the most significant—yet often overlooked—tax advantages available in the markets. If you primarily trade stocks or stock options, you’re likely paying your highest marginal tax rate on short-term gains. But there’s a whole category of instruments, specifically defined by the IRS, that get dramatically better tax treatment right out of the box.
We’re talking about Section 1256 contracts.
Understanding these contracts and the unique “60/40 rule” that applies to them is crucial, especially if you trade or are considering trading futures. Our team leans heavily into futures for precisely this reason—the built-in tax efficiency is a powerful edge that stock traders simply don’t have for short-term trading.
In this guide, we’ll break down exactly what Section 1256 contracts are, which popular instruments qualify (and which don’t), how the magical 60/40 rule saves you money, and how it all gets reported. Let’s dive in.
What Are Section 1256 Contracts? (IRS Definition)
The term comes directly from Section 1256 of the Internal Revenue Code. It defines a specific group of financial contracts that receive special tax treatment. According to the IRS, these include:
- Regulated Futures Contracts: Contracts traded on or subject to the rules of a qualified board or exchange (like the CME, NYMEX, COMEX, CBOT). This covers most futures contracts you’d likely trade.
- Foreign Currency Contracts: Specifically, certain futures contracts involving major currencies traded on regulated exchanges. Spot forex or CFD forex typically doesn’t qualify.
- Non-Equity Options: This is a key category. It includes options based on commodities, debt instruments, foreign currency, and, most importantly for many traders, broad-based stock market indexes settled in cash (like options on the S&P 500 index – SPX).
- Dealer Equity Options & Dealer Securities Futures Contracts: These are less common for retail traders and apply mainly to market makers and dealers.
The common thread? These are generally exchange-traded, standardized contracts marked-to-market daily by the exchanges.
The Magic Number: Understanding the 60/40 Tax Rule
This is the core benefit and why Section 1256 contracts are so attractive. Regardless of how long you hold the contract—whether it’s 10 seconds or 10 months—any capital gain or loss is automatically treated as:
- 60% Long-Term Capital Gain/Loss: Taxed at the lower long-term capital gains rates (currently 0%, 15%, or 20% depending on your income).
- 40% Short-Term Capital Gain/Loss: Taxed at your higher, ordinary income tax rate (currently 10% to 37%).
Why This Matters: No 1-Year Holding Period Needed!
Think about that. With stocks, you must hold a position for more than one year to qualify for the lower long-term capital gains rates. If you day trade stocks, 100% of your net profits are taxed at your highest ordinary income rate.
With Section 1256 contracts, you get the benefit of the lower 60% long-term rate even on trades lasting minutes or seconds. It’s a significant, built-in tax discount for short-term traders.
Automatic Mark-to-Market (MTM) Treatment
Another key feature of Section 1256 contracts is that they are automatically marked-to-market for tax purposes at the end of the year.
How Year-End MTM Works for 1256 Contracts
Similar to the elective Section 475(f) MTM for stock traders, the IRS requires that any open Section 1256 contracts held on the last business day of the year be treated as if they were sold at their fair market value.
- You recognize the unrealized gain or loss for the tax year.
- This gain or loss gets the 60/40 treatment.
- Your cost basis in the contract is adjusted to that year-end market value for the following year.
Comparison: Section 1256 MTM vs. Section 475(f) MTM Election
It’s crucial not to confuse these two:
- Section 1256 MTM:
- Applies To: Specific contracts (futures, SPX options, etc.).
- Treatment: 60% Long-Term / 40% Short-Term Capital Gain/Loss.
- Is it Elective? No, it’s mandatory for these contracts.
- Section 475(f) MTM Election:
- Applies To: Securities (stocks, stock options) for qualifying traders who elect it.
- Treatment: 100% Ordinary Income/Loss.
- Is it Elective? Yes, requires Trader Tax Status and a timely election.
See our guide on the Elective Section 475(f) MTM
Which Instruments Qualify? (And Which DON’T)
Knowing which specific products get this favorable treatment is critical.
Qualify: ✅
- Major Index Futures: E-mini S&P 500 (/ES), Nasdaq 100 (/NQ), Dow (/YM), Russell 2000 (/RTY).
- Commodity Futures: Crude Oil (/CL), Natural Gas (/NG), Gold (/GC), Silver (/SI), Corn (/ZC), Soybeans (/ZS), Bonds (/ZB, /ZN).
- Currency Futures: Euro FX (/6E), British Pound (/6B), Japanese Yen (/6J) traded on exchanges like CME.
- Options on Futures: Options contracts where the underlying asset is a futures contract.
- Broad-Based Index Options (Cash-Settled): Options directly on major indexes like the S&P 500 (SPX), Nasdaq 100 (NDX), Russell 2000 (RUT), and Volatility Index (VIX).
Do NOT Qualify: ❌
- Individual Stocks: (AAPL, TSLA, MSFT, etc.)
- Options on Individual Stocks: (AAPL Calls/Puts, TSLA Calls/Puts)
- Exchange-Traded Funds (ETFs): (SPY, QQQ, IWM, GLD, USO)
- Options on ETFs: (SPY Options, QQQ Options, IWM Options)
- Most Spot Forex Contracts: (Unless they meet specific requirements of exchange-traded futures).
- Contracts for Difference (CFDs)
- Cryptocurrencies (Generally treated as property, not Section 1256 contracts)
The Critical SPX vs. SPY Options Distinction
This is a huge point of confusion.
- SPX options are options on the S&P 500 index itself. It’s a cash-settled, broad-based index option. SPX options ARE Section 1256 contracts and receive 60/40 tax treatment.
- SPY options are options on the SPDR S&P 500 ETF. Because an ETF is treated like a stock for these purposes, SPY options are NOT Section 1256 contracts. They are taxed like regular stock options (short-term or long-term capital gains based on holding period).
The same logic applies to NDX options (1256 contract) vs. QQQ options (not 1256). For active index options traders, choosing SPX over SPY can lead to significant tax savings due to the 60/40 rule.
Reporting Your Gains and Losses: Form 6781
You don’t report Section 1256 gains and losses directly with your stock trades on Form 8949. They have their own dedicated form.
How 1099-B Data Flows to Form 6781
Your broker will typically report your aggregate Section 1256 profit or loss for the year in a summarized section on your Form 1099-B (Box 11). This single number represents the net result of all your 1256 trades and the year-end mark-to-market adjustment.
How Form 6781 Calculates the 60/40 Split
You report this aggregate profit or loss on IRS Form 6781, Part I. The form itself then walks you through the calculation:
- You enter the net gain or loss.
- The form automatically allocates 40% as short-term capital gain/loss.
- It allocates the remaining 60% as long-term capital gain/loss.
Where it Goes on Schedule D
The results from Form 6781 then flow directly to your Schedule D (Capital Gains and Losses):
- The short-term portion goes to the short-term section (Part I).
- The long-term portion goes to the long-term section (Part II).
The Unique Loss Carryback Rule for Section 1256
Section 1256 contracts have another unique feature regarding losses. While typical net capital losses (from stocks, etc.) can only be carried forward to future tax years (after the initial $3,000 deduction), net losses specifically from Section 1256 contracts have an optional carryback provision.
- You can elect to carry back a net Section 1256 loss up to three preceding tax years.
- However, the carryback can only be used to offset prior year Section 1256 gains. It cannot offset prior year ordinary income or regular capital gains.
- You must carry it back to the earliest year first. Any remaining loss is then carried forward.
This can be valuable if you had large Section 1256 gains in recent profitable years followed by a losing year.
Tax Treatment Showdown: Futures vs. Stocks for Day Traders
Let’s put it all together with a simple example to see the real dollar impact.
A Calculation Example: $10k Profit Scenario
Assume you are a day trader in the 24% federal tax bracket for ordinary income/short-term gains and the 15% bracket for long-term capital gains. You made a net profit of $10,000 for the year.
- Scenario 1: Trading Stocks (Short-Term Capital Gains)
- $10,000 profit taxed at your ordinary rate of 24%.
- Total Tax = $2,400
- Scenario 2: Trading /ES Futures (Section 1256 Contracts)
- 60% Long-Term Portion: $10,000 * 60% = $6,000 taxed at 15% = $900
- 40% Short-Term Portion: $10,000 * 40% = $4,000 taxed at 24% = $960
- Total Tax = $900 + $960 = $1,860
Result: By trading futures instead of stocks, you saved $540 in federal taxes on the same $10,000 profit. The savings become even more significant at higher profit levels and higher tax brackets.
(Note: This is a simplified example for illustration purposes only. State taxes also apply. Consult a tax professional for advice specific to your situation.)
- See our Futures Day Trading Strategy for /ES and /NQ
- Compare Futures vs. Stocks in our Day Trading Markets guide
Our Team’s Verdict: Why Futures Traders Have a Built-In Edge
For active, short-term traders, the tax treatment of Section 1256 contracts offers a clear, undeniable advantage over trading stocks or ETFs. The 60/40 rule provides immediate access to lower long-term capital gains rates without requiring a long holding period. Combined with the automatic mark-to-market accounting simplifying year-end reporting, it makes futures and qualifying index options highly efficient vehicles from a tax perspective.
While taxes shouldn’t be the only reason you choose a market, understanding the significant benefits of Section 1256 is a critical piece of the puzzle when building a comprehensive trading plan.
- Section 1256 is a key part of our Ultimate Guide to Day Trading Taxes.
- Understand your overall status with our Trader Tax Status guide.
Frequently Asked Questions (FAQ) About Section 1256 Contracts
What qualifies as a Section 1256 contract?
Quick Answer: Regulated futures contracts, certain foreign currency contracts, and non-equity options (like broad-based index options such as SPX).
The main categories defined by the IRS are regulated futures (like /ES, /CL, /GC), options on those futures, certain currency futures traded on exchanges, and options on broad-based cash-settled indexes (SPX, NDX, VIX, RUT). It does not include individual stocks, stock options, ETFs, or ETF options (like SPY options).
Key Takeaway: If you’re trading futures on a major exchange or options directly on indexes like SPX, you’re likely dealing with Section 1256 contracts.
What is the 60/40 rule for taxes?
Quick Answer: All capital gains/losses on Section 1256 contracts are treated as 60% long-term and 40% short-term, regardless of holding period.
This rule gives traders a blended tax rate. 60% of the profit or loss is taxed at the generally lower long-term capital gains rates (0%, 15%, or 20%), and the remaining 40% is taxed at the higher short-term capital gains rates (which match your ordinary income tax bracket).
Key Takeaway: The 60/40 rule is the primary tax advantage of Section 1256 contracts, especially for short-term traders.
How are futures taxed differently than stocks?
Quick Answer: Futures (as Section 1256 contracts) get the favorable 60/40 tax split and use mark-to-market accounting automatically. Short-term stock trades are taxed 100% at higher ordinary income rates.
A $10,000 short-term gain on stock is taxed entirely at your ordinary income rate. The same $10,000 gain on a futures contract is taxed as $6,000 long-term capital gain and $4,000 short-term capital gain, resulting in a lower overall tax bill. Futures are also marked-to-market annually, while stocks are only taxed upon sale (unless you elect Section 475 MTM).
Key Takeaway: Futures generally have significantly better tax treatment for short-term trading profits compared to stocks.
Are SPY options Section 1256 contracts?
Quick Answer: No, they are not. SPX options are.
SPY is an Exchange-Traded Fund (ETF) that tracks the S&P 500 index. Options on ETFs (like SPY options) are treated like options on individual stocks – they are not Section 1256 contracts. SPX options, however, are options on the S&P 500 index itself (a broad-based cash index) and do qualify as Section 1256 contracts.
Key Takeaway: Trading SPX options offers the 60/40 tax advantage; trading SPY options does not.
How do I report Section 1256 gains and losses?
Quick Answer: You report the net gain or loss on IRS Form 6781, Part I.
Your broker will typically provide an aggregate net gain/loss figure for your Section 1256 contracts on your Form 1099-B (Box 11). You transfer this total to Form 6781. The form itself then calculates the 60% long-term and 40% short-term portions, which you then carry over to Schedule D of your Form 1040.
Key Takeaway: Form 6781 is specifically designed for reporting Section 1256 activity and applying the 60/40 split.
Do Section 1256 contracts use mark-to-market?
Quick Answer: Yes, automatically.
Unlike the Section 475(f) election which is optional for qualifying stock traders, mark-to-market accounting is mandatory for Section 1256 contracts under the tax code. Any open positions at year-end must be treated as if sold at fair market value, and the unrealized gain or loss is recognized and taxed according to the 60/40 rule.
Key Takeaway: Mark-to-market is inherent to the tax treatment of Section 1256 contracts.
Can Section 1256 losses be carried back?
Quick Answer: Yes, net Section 1256 losses can be carried back up to three years, but only against prior Section 1256 gains.
If you have a net loss on your Form 6781, you can elect to carry that loss back to offset net Section 1256 gains reported in any of the three preceding tax years (starting with the earliest year). This is different from regular capital losses which generally only carry forward. Any loss not used in the carryback can then be carried forward.
Key Takeaway: This unique carryback provision offers potential tax recovery opportunities after a losing year in futures/1256 trading.
Is there a holding period requirement for the 60/40 rule?
Quick Answer: No. The 60/40 split applies regardless of how long you held the contract.
Whether you held a futures contract for 5 seconds or 5 months, if you realize a gain or loss, it will be treated as 60% long-term and 40% short-term. This complete decoupling from the standard >1 year holding requirement for long-term capital gains is what makes Section 1256 so advantageous for active traders.
Key Takeaway: Holding period is irrelevant for the 60/40 tax allocation on Section 1256 contracts.
