Question: What does "Section 1256 contract net losses can be carried back three years" mean?

[fanfare]

"I wonder why"

If the market moves against you, and you don't take immediate action, the buying power in your trading account can be wiped out overnight.

Then you will have a negative balance and possibly a margin call.

@gyaqwe 

[fanfare]

For this reason the initial margin requirements for futures  are very high and/or the broker won't approve you.

This eliminate a large fraction of traders.

[Mike9241]

It’s a three-year carryback; unused amounts carry forward.

first, you must figure the eligible amount to carryback from the loss year

second, then you must figure the amount that can be used in the third prior year. the amount that can't be used carries forward to the second prior year and then the first. then any lft is carryforward but subject to the general rules for capital gains and losses.

I wonder why more folks don't do Sec 1256 trading? So many benefits especially from a Tax standpoint.

volatility. i have known traders that have ended up bankrupt.  consider future contracts for barrels of oil a few months back. the price was up to around $100 and has now fallen.  some traders probably bought at $100 only to see the price fall.  big positions would have taken big losses. 

[Mike9241]

@fanfare some foreign houses may have no margin requirement I had a client many years back that traded through a British broker.  Even flew on the Concorde back and forth to England to discuss strategy.  the problem was there were two very wealthy individuals who were trying to corner the silver market. they were manipulating the price. my client lost an amount of over 6 figures but paid off the broker,

read about the Hunt brothers. 

[Fred58]

@Mike9241 so you can only carry back section 1256 losses to years when you did section 1256 trading? i.e. if I had $2,100 remaining in 1256 losses in 2022, a 1256 gain of $1,000 in 2021 and no 1256 trading in 2020, then I can only carry back $1,000 to my 2021 return and the remaining $1,100 would go towards 2023? I only started trading those contracts in 2021.

[DianeW777]

The amount you can carry back to any prior year is limited to the smaller of: 

• The gain, if any, that you would report on line 16 of Schedule D (Form 1040) for that carryback year if only gains and losses from section 1256 contracts were taken into account; or 

• The gain, if any, reported on line 16 of Schedule D (Form 1040) for that carryback year.

• For more information  you can click following links: 
  • Instructions Form 6781
  • What is Form 6781?

If you need to amend or carry back a loss from 1256 contracts please review information for amending your return below.

• How to amend (change or correct) a return already filed?
• Do I need to amend? 
• What is the deadline for amending returns?

@Fred58 

[john9yao]

Conceptionally, I understand what does carry back do.  And I saw I can input a loss for the "carry back".  But how do I amend the 2021 return for the carry back I entered for 2022 return?

I used the TurboTax Premier desktop version for both 2021 and 2022.  When I am doing the 2021 amendment in 2021 TurboTax Premier, where do I put in the carry back amount?  Thanks

[DianeW777]

First, it's important to note that you must carry it back three years and then forward, to the extent there is Section 1256 gains in the earliest year (see the information below for more detail).  If not, then you carry it forward to the second year, the first year and then over to 2023.  You amend or change the 6781 Form and the Schedule D for the loss carryback. 

It's best to use Form 1045, however TurboTax does not support IRS Form 1045 Application for Tentative Refund

• IRS Form 1045 
• IRS Form 1045 instructions 

The amount you can carry back to any prior year is limited to the smaller of:

• The gain, if any, that you would report on line 16 of Schedule D (Form 1040) for that carryback year if only gains and losses from section 1256 contracts were taken into account; or

• The gain, if any, reported on line 16 of Schedule D (Form 1040) for that carryback year.

• IRS Form 6781
• What is Form 6781- Section 1256 Gains and Losses

Completing the form is similar to reporting any type of investment. Here’s the breakdown:

• Part I: Report your Section 1256 investment gains and losses at either the actual price at which you sold these investments or the "mark-to-market" price established on December 31 if you have not sold the investment.
• Part II: Report the gains and losses on your straddles, with losses reported in Section A and gains in Section B.
• Part III: Meant for any unrecognized gains you have on positions held at the end of the tax year, but you only have to complete it if you have a recognized loss on a position.

You might consider a tax preparer to assist you with this.

@john9yao 

[fanfare]

The instructions for Form 6781 tells you exactly how to recalculate schedule D amount for the prior year that you want to apply a carryback. Do it that way.

you may have to get the prior year forms in fillable PDF format from IRS, if you can't cajole TurboTax to enter the result of this calculation.

[slsp]

Can someone confirm this please -

1256 losses can only be offset against previous 1256 gains? 

Is there a way to offset it against regular capital gains?  TIA

[john9yao]

Let's say that you have a Section 1256 losse on 2022 return, and you want to carryback.  So you can carryback to 2019, 2020 and 2021.  You will need to file 1040X in the order of 2019, 2020, and 2021.  However, you can also carryback all the losses to 2021, and only file 1040X for 2021.

[john9yao]

Not true.  According to the Form 6781 instruction -

The amount you can carry back to any prior year is limited to the smaller of:
• The gain, if any, that you would report on line 16 of Schedule D (Form 1040) for that carryback year if only gains and losses from section 1256 contracts were taken into account; or
• The gain, if any, reported on line 16 of Schedule D (Form 1040) for that carryback year.

[DawnC]

Yes,  For tax purposes, every Section 1256 gain or loss is treated as being 60% long-term and 40% short-term, no matter how long you own it.

• Long-term gains, defined as those held for longer than one year, generally have more advantageous tax characteristics than short-term gains, which are held for one year or less.

Form 6781 and instructions

Page 3 - The amount you can carry back to any prior year is limited to the smaller of: 

• The gain, if any, that you would report on line 16 of Schedule D (Form 1040) for that carryback year if only gains and losses from section 1256 contracts were taken into account; or 

• The gain, if any, reported on line 16 of Schedule D (Form 1040) for that carryback year. 

The amounts just described are figured prior to any carryback from the loss year. Also, the carryback is allowed only to the extent it doesn’t increase or produce a net operating loss for the carryback year. The loss is carried to the earliest year first.    @slsp 

[slsp]

Thanks.  So to eli5, if you don't have any 1256 gains in the past, there is no way to carryback 1256 losses, right?

[john9yao]

Wrong.  Accirding to the Form 6781 instruction - 

The amount you can carry back to any prior year is limited to the smaller of:

• The gain, if any, that you would report on line 16 of Schedule D (Form 1040) for that carryback year if only gains and losses from section 1256 contracts were taken into account;

OR

• The gain, if any, reported on line 16 of Schedule D (Form 1040) for that carryback year.

So if the carryback year line 16 of Schedule D is positive, you can.