Forex: Section 988 vs the 1256 election
Lesson 13 · about 9 min
Education, not tax advice: rules, rates and thresholds change every year, so confirm anything you plan to act on with a qualified tax professional.
Currency trading sits in an odd corner of the code. The default treatment is neither capital gain nor 1256; it is a third regime, Section 988, and some traders can opt out of it into 1256. Which regime applies depends on what you trade, and the opt-out has a timing rule that surprises nearly everyone who learns about it after the fact.
Section 988: the default for currency
Section 988 was written for businesses with foreign-currency exposure, and it treats gains and losses on foreign currency transactions as ordinary income or loss. Retail spot forex (EUR/USD through a forex broker, rolled nightly) falls under it by default.
Consequences:
- Gains are ordinary, taxed at your marginal rate. No long-term rate, no 60/40.
- Losses are ordinary too, which means no $3,000 cap. A $40,000 spot forex loss offsets $40,000 of salary or other income in the same year.
- No wash sale rule, because currency is not a security.
- Reported as "other income" (or loss) on the return, typically via Schedule 1 or, for a trader with TTS, on Form 4797 or Schedule C, depending on the position taken.
- Most forex brokers do not issue a 1099 for spot forex. The income is still reportable; the absence of a form is not an absence of tax.
Section 1256: currency futures and the election
Currency futures on a US exchange (6E, 6J, M6E and the rest) are regulated futures contracts, so they are 1256 automatically: 60/40, mark-to-market, Form 6781. No election is needed and 988 never applies.
For forward contracts and, by the reading most retail brokers and many practitioners apply, retail spot forex that functions like forwards, Section 988(a)(1)(B) allows a taxpayer to elect out of 988 and into capital-gain treatment, which for qualifying contracts means 1256's 60/40. The IRS has not issued definitive guidance on whether over-the-counter retail spot forex qualifies for the election, and the question has been litigated with mixed reasoning. This is a genuine grey area; a trader who relies on the election for spot forex is taking a position, and a professional should be involved in taking it.
The timing rule
The election out of 988 must be made before the close of the day on which the transaction is entered into, in the taxpayer's own books and records. It is not filed with the IRS at that time; it is an internal, contemporaneous note (many traders keep a dated statement in their trading records and some notify their broker). You cannot decide in April that last year's forex was 1256. Once made, the election covers future transactions until revoked, and it can be made for all contracts or for identified ones.
A practical consequence: a trader who has never documented an election is in 988 for everything they have done so far, whatever they intended.
Worked comparison
Illustrative rates: 24% ordinary, 15% long-term. Two years for a spot forex trader who could, hypothetically, qualify for the election.
Year 1: a $30,000 gain.
| Section 988 (default) | 1256 via election | |
|---|---|---|
| Character | Ordinary | 60/40 |
| Federal tax | $30,000 × 24% = $7,200 | $18,000 × 15% + $12,000 × 24% = $5,580 |
The election saves $1,620.
Year 2: a $30,000 loss, with $80,000 of other income.
| Section 988 (default) | 1256 via election | |
|---|---|---|
| Character | Ordinary loss | 60/40 capital loss |
| Usable this year | $30,000 against other income | $3,000 against other income (plus any capital gains; plus optional 3-year carryback against prior 1256 gains) |
| Federal tax reduction at 24% | $7,200 | $720 now, remainder carried forward or back |
The election costs $6,480 of current-year relief.
The pattern is the same trade-off the code offers everywhere: 988 favors losers and 1256 favors winners. Because the election must be made before trading, it is a bet on your own future results. A trader who is unsure of their edge gets a built-in cushion from 988; a consistently profitable trader pays more under it.
Which regime you are in, by product
| Product | Default regime | Election possible? |
|---|---|---|
| Spot forex at a retail broker | Section 988 (ordinary) | Grey area; contemporaneous election out |
| Forex forwards (interbank) | Section 988 | Yes, contemporaneous election out to 1256 |
| Currency futures (CME 6E etc.) | Section 1256 | Not needed |
| Options on currency futures | Section 1256 | Not needed |
| Currency ETFs (shares) | Capital asset; some are structured as trusts with their own quirks | No |
Record keeping for forex
Because there is often no 1099, your own records are the only source. Keep the broker's annual statement and a full trade export, note the rollover interest separately (it is ordinary income under 988 either way), and keep a dated copy of any election you have made. If the broker is outside the US, the account may trigger FBAR and Form 8938 foreign-account reporting once balances cross the thresholds (Module 5).
Key idea: Spot forex is ordinary income and ordinary loss under Section 988 by default, with no $3,000 cap and no wash sales. An election into 60/40 capital treatment exists but must be made before the trade, in your own records, and its availability for retail spot forex is unsettled.
Try it: Check whether your forex broker issued any tax form for last year. If not, pull the annual statement and compute your net result yourself. Then write a one-line dated note of which regime you are treating your forex under. Whether or not you ever elect, knowing which side of the line you stand on is the first step.
Recap
- Section 988 (default): ordinary gain or loss, no loss cap, no wash sales, often no 1099.
- Currency futures on US exchanges are 1256 automatically.
- An election out of 988 into 60/40 must be made contemporaneously, before the transaction; its reach to retail spot forex is a grey area.
- 988 favors losing years (full ordinary loss), 1256 favors winning years (blended rate); the choice is prospective.
- Keep your own records; the broker may not report anything to the IRS.