The 60/40 rule: how Section 1256 contracts are taxed

Most investments are taxed on a simple rule: hold longer than a year for the lower long-term capital gains rate, sell sooner and pay ordinary rates. A special category called Section 1256 contracts — regulated futures, certain broad-based index options, and a few other instruments — plays by different rules entirely. Their gains get a fixed 60/40 blend of long- and short-term treatment no matter how briefly you held them, and they are 'marked to market' at year-end.

The 60/40 split

For a Section 1256 contract, 60% of your gain (or loss) is treated as long-term and 40% as short-term — even if you held the position for a single day. Because long-term rates are lower than short-term (ordinary) rates, this blend produces a maximum federal rate meaningfully below the top ordinary rate for active traders who would otherwise pay short-term rates on everything.

Mark-to-market at year-end

Section 1256 contracts you still hold on December 31 are treated as if you sold them at year-end market value ('mark-to-market'), so unrealized gains and losses are reported that year. This removes the ability to defer by simply not selling — but it also means losses are recognized without a sale, and Section 1256 losses can even be carried BACK three years against prior 1256 gains, a rare feature.

What is (and is not) a 1256 contract

The bottom line

Section 1256 contracts — regulated futures and many broad-based index options — are taxed on a 60/40 long/short blend regardless of holding period, giving active traders a structurally lower rate than short-term stock trading, and they are marked to market at year-end with a rare loss-carryback option. The catch is classification: qualifying instruments are specific and the rules technical. For frequent traders, understanding 1256 can materially change after-tax returns.