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If an investor writes a 1256 based option $1000 in January and the option expires worthless in February that is a capital gain. Is it true that, since it is 1256 based, that the capital gains are taxes as if 60% long and 40% short even though the holding period was less than a year? In support of this position, I refer the reader to the following URL:

26 U.S. Code § 1256 - Section 1256 contracts marked to market

This seems too good to be true. My question is, if an investor has a short option position and he closes the option position out a few months later at a gain, is 60% of the gain long term?

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  • Is there a question here?
    – Joe
    Commented Feb 23, 2016 at 22:35
  • @Joe - I rephrased it in terms of a question.
    – user32479
    Commented Feb 23, 2016 at 22:59

1 Answer 1

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I believe that you are correct. In your case you benefit from this rule. Had you carried it longer than a year, I believe that you would still get the 60/40 split, so, in that case, the rule would not benefit you because under the usual rules you would have gotten 100% long-term treatment.

Here's the history as presented by wikipedia:

Any gain or loss from a 1256 Contract is treated for tax purposes as 40% short-term gain and 60% long-term gain. Typically the gain from any non-1256 contract will be taxed 100% at the short-term rate because the position is usually held for less than 12 months. Since most futures contracts are traded in a much shorter time frame than the 12 month rule required by the IRS for long term capital gains treatment, this creates an inherent tax disadvantage. Thus the 1256 Contract designation enhances the marketability based on the after-tax attractiveness of these products. The reason for the implementation of this tax code was due to the fact that traders were hedging their short term futures contracts (going long and short at the same time) in order to transition to the next tax year without paying the short-term capital gains tax on these positions and effectively making these positions qualify for long-term tax treatment.

https://en.wikipedia.org/wiki/1256_Contract

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