Forex gains and losses?

[Mike9241]

it depends

hopefully, this thread will provide the info you need.

not clear what you're trading but the trades could fall under section 988 (ordinary) or section 1256 (capital) depending on the choices you make and where and how traded.

https://www.thetaxadviser.com/issues/2009/nov/treatmentofforeigncurrencyoptiongains.html 

notice the requirements to have a qualifying section 988 {IRC sec 988(a)(1)(B)} transaction treated, at your option, as a 1256 transaction. 1256 transactions get treated as 60% long-term capital and 40% short-term capital

1256 gets entered under contracts and straddles form 6781 .

[DJS]

For tax purposes, forex options and futures contracts are considered IRC Section 1256 contracts, which are subject to a 60/40 tax consideration. In other words, 60% of gains or losses are counted as long-term capital gains or losses, and the remaining 40% is counted as short term. But I understand that you're not trading futures or options. 

Most spot traders are taxed according to IRC Section 988 contracts, which are for foreign exchange transactions settled within two days, making them open to treatment as ordinary losses and gains. If you trade spot forex, you will likely be grouped in this category as a "988 trader." If you experience net losses through your year-end trading, being categorized as a "988 trader" is a substantial benefit. As in the 1,256 contract category, you can count all of your losses as "ordinary losses," not just the first $3,000.

Now comes the tricky part: Deciding how to file taxes for your situation. While options or futures and OTC are grouped separately, the investor can choose to trade as either 1256 or 988. Individuals must decide which to use by the first day of the calendar year.

Form 6781 is used to report: 

• Any gain or loss on section 1256 contracts under the mark-to-market rules. 
• Gains and losses under section 1092 from straddle positions.

Therefor whether or not you need this form depends on the whether you decided to file as a 988 or 1256 trader. 

[calvin5425]

I read your comment on how to report 988 income/loss and wanted to make sure that you are saying it's okay to report a loss in the same manner.  thanks

Calvin 

[DJS]

Before you enter your foreign currency transactions, you must determine whether the gain or (loss) is subject to IRC (Internal Revenue

Yes, you report and gain or a loss in the same manner.

Code) 1256 or 988. If you are unsure how to classify your trades, it is best to seek professional tax advice from your broker or a tax attorney.

By default, Cash Forex is subject to IRC 988 rules with ordinary gain or (loss) treatment. However, if you are a trader, you can elect out of IRC 988. This will allow your gains to be treated as IRC 1256 with beneficial 60/40 capital gain treatment. The election out of IRC 988 is an internal election. This means you should document the election in your own records before you make the trades.

IRC 988:

If you did NOT elect out of IRC 988, the gain or (loss) would be subject to IRC 988. You would enter the information on Schedule 1 (Form 1040) Additional Income and Adjustments to Income, Line 8 as an ordinary gain or (loss).

To enter a description and an amount for Schedule 1 (Form 1040), Line 8:

[samzandt]

Reading Code Section 988, it seems as if "spot FX" trades; e.g. selling GBP for USD is only a Section 988 Transaction, if didn't have GBP in your account to sell and you were borrowing the GBP (with the obligation to repay it). Conversion of GBP owned in your account to USD it seems would not constitute a Section 988 Transaction and would be a Capital Gain/(Loss). Do you agree?

See definition of Section 988 Transaction in link below. It refers (i) acquition of debt, (ii) accruing expense/income to be paid/received later, or (iii) forward, future or option contract. All these have the feature of some kind of settlement in the future, not conversion of currency.

I am far from knowledgeable in tax law, so genuinely seeking guidance. Appreciate any views...

[fanfare]

@samzandt 

You can elect to have FOREX and currency transactions to be treated under Section 1256.
How to do it.
Write yourself a letter documenting your intention signed and dated before you start trading,
and put with your tax records.
Then you can report FOREX on Form 6781.
Otherwise your Forex trades are ordinary income.

If you report a huge FOREX loss on the "Other Income" line, I think you can expect to be audited.

[samzandt]

I have a rather large FOREX loss which I would like to classify as Section 988 which would go under Other Income. If this is the requirement why would I get audited?

[samzandt]

I'm not a FOREX Trader, just retail guy that was compensated in stock denominated in GBP. I subsequently sold the stock and received GBP. I held the GBP for over 1 year and through broker (Interactive Broker) sold GBP for USD on the spot market for a loss (using the basis determined by GBP/USD at time of stock sale). Is this still consider a Section 988 Transaction, in which I can show a loss in Other Income or do I have to report as a capital gain/(loss) which would be limited to loss of $3,000? I can't find this particular transaction in the definition of Section 988 Transaction. The definition of Disposition, in the definition that says "disposition of any nonfunctional currency" is a Section 988 Transaction, is very complicated and refers to stock, but it is impossible to decipher. Any advice? 

Thank you!

[initialt]

I am at a loss for 2022, deducting the loss very help with my taxable income, as it does reduced my taxes. But I have a question that seem I cannot find an answer to. 

Do I report the loss on Federal and State (CA) in where I live? or only FED side?

[RobertB4444]

If you report this transaction on your federal return the system will carry the necessary information over to your California return automatically.

@initialt