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In a recent op-ed, Warren Buffet made a claim about investment managers:

Others own stock index futures for 10 minutes and have 60 percent of their gain taxed at 15 percent, as if they’d been long-term investors.

Now I thought capital gains required you to hold for a year and a day. What trick is Buffet referring to here?

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A Section 1256 contract is any:

  1. Regulated futures contract
  2. Foreign currency contract
  3. Non-equity option

Non-equity options include debt options, commodity futures options, currency options, and broad-based stock index options. A broad-based stock index is based upon the value of a group of diversified stocks or securities (such as the Standard and Poor's 500 index).

60% of the capital gain or loss from Section 1256 Contracts is deemed to be long-term capital gain or loss and 40% is deemed to be short-term capital gain or loss. What this means is a more favorable tax treatment of 60% of your gains.

http://www.tradelogsoftware.com/tax-topics/futures/

It's a really wierd rule (arbitraty 60% designation, so broad, etc), but section 1256 contracts get preferential tax treatment and that's what Buffett's talking about.

  • 2
    A fine example of the corruption sprinkled throughout our tax code. – mgkrebbs Aug 15 '11 at 16:25
  • 10
    what worries me is that I don't understand any of this. – jokoon Aug 15 '11 at 18:11
  • 1
    This kind of treatment actually makes sense with regard to index funds, since they generally only sell-off a security when the holdings of the index are altered, and in that situation, the holding has been in the index usually for more than a year. However I agree that on Options and Futures, I just don't see a reason to treat any gains as long term unless the length of the option or contract itself is more than a year. – Chuck van der Linden Aug 15 '11 at 18:16
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    Even though the holding has been in the index, the purchaser of the contract has not necessarily held on for that long. I don't see why an investor should be rewarded with long-term gain treatment when the period of holding could be very short. – BlackJack Aug 15 '11 at 18:42
  • We're in agreement Blackjack. Index funds get some treatment like this, but I believe under a different section of the rules. Since this section is all about contracts and options, it doesn't make sense to me unless the holder of the contract or option had it more than a year before exercising – Chuck van der Linden Aug 15 '11 at 21:40

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