United States

Navigating the advantages, disadvantages of section 1256 in a down market


Various commodity prices have fallen sharply during the past year. Many investors, traders and investment managers have realized taxable losses as a result. Some of these losses may be in the form of section 1256 contracts. Generally, a section 1256 contract is any regulated futures contract, foreign currency contract, nonequity option, dealer equity option or dealer securities futures contract.

Taxpayers with net losses from such contracts should be aware of certain planning opportunities and elections. Many taxpayers are familiar with the general capital loss rules for individuals who do not allow carrybacks. Unused losses may only be carried forward. Lesser known is the section 1256 carryback election. This election enables, in certain circumstances, an eligible taxpayer to carryback current-year section 1256 losses to reduce section 1256 gains in an earlier year. The tax code, not being known for its simplicity, contains several complicating factors to making the section 1256 carryback election. Possible late elections, mixed straddle and the capital gains tax rate are but three examples of potential complications.

Essentially, carrying back section 1256 losses can provide some cash now by offering a refund of previously paid tax. But there is also potential for a smaller overall benefit than carrying forward the losses would yield, if tax rates are higher in later years. The rules for making section 1256 carryback are complicated. Taxpayers interested in making such an election should consult a competent tax advisor.


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