Do you trade futures or index options? If so, then you need to know about newly enhanced support for these instruments in TradeLog software. With the release of TradeLog version 9.3 traders and investors can not only identify section 1256 contracts but also generate accurate tax reporting at year-end.
What is a Section 1256 Contract?
The IRS defines section 1256 contracts as:
Many traders deal with futures trades and broad-based index options. TradeLog has default settings to identify these securities in your trade history and flag them for section 1256 handling. In addition you can customize the settings to define other securities as futures or broad-based index options. This is especially important because many brokers do not identify broad-based index options as section 1256 contracts on their 1099-B reporting.
When it comes to tax reporting, section 1256 contracts are treated differently from other securities. Thus, TradeLog has classified and segregated these so that they are not included in IRS Form 8949. However, in the past TradeLog did not do much with section 1256 trades besides exclude them from the other trades. We enabled users to run a gains and losses report for futures trades, and that was about it. But there are special rules that apply to section 1256 contracts and in recent years we have found that many traders are not aware of the rules, nor do they have a way to properly account for these.
Section 1256 Contracts Marked to Market
IRS Publication 550, page 40 states:
If you hold a section 1256 contract at the end of the tax year, you generally must treat it as sold at its fair market value on the last business day of the tax year.
This means Section 1256 Contracts are to be marked to market at year end. Some people get confused by this statement because they think it applies only to traders using mark-to-market accounting, but there is a difference!
A trader who elects Section 475(f) with the IRS is electing to use mark-to-market accounting for some or all of their trading gains and losses (depending on their election).
However, even if you are an average trader or investor and you have not elected section 475(f), you still must account for Section 1256 Contracts as marked-to-market at year end. This has been the rule for a long time. In the past, TradeLog did not include functions for making these year-end mark-to-market adjustments on futures. Some users made entries manually. Some used the TradeLog MTM versions to make the entries. Some didn’t even bother.
TradeLog version 9.3 now includes enhanced support for futures. Since the proper accounting requires mark-to-market handling, an MTM version of TradeLog is needed in order to fully support section 1256 contracts.
If you have futures or index options in your account, here is what happens in TradeLog MTM:
Section 1256 contracts are typically reported using IRS Form 6781. In order to complete this form a trader needs to know the total losses and the total gains from trading section 1256 contracts – after mark to market accounting adjustments have been made. The net gain or loss is then split 60/40 for long term / short term handling respectively. The resulting amounts are then recorded on Schedule D.
TradeLog version 9.3 onward contains a report for Form 6781. This has specifically been designed to provide the total gains and losses needed for Form 6781. The IRS does not require detailed trade history for Form 6781, however, the TradeLog report provides you with the detail for your own tax records.
There are, of course, exceptions and special rules that apply in various situations which we cannot possibly outline completely in this article. The information we provide here is for general direction in handling these instruments. If you trade in section 1256 contracts we recommend you become fully aware of the special tax requirements involved. Plus you will want to make sure you have a version of TradeLog that will handle all your trader tax accounting needs.
Please note: This information is provided only as a general guide and is not to be taken as official IRS instructions. Cogenta Computing, Inc. does not make investment recommendations nor provide financial, tax or legal advice. You are solely responsible for your investment and tax reporting decisions. Please consult your tax advisor or accountant to discuss your specific situation.