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

[VAer]

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

I don't quite understand it, could someone please explain it in plain language with example. For example, if I have section 1256 contract net loss of $30,000 this year (just an example), how does it affect my tax return. Particularly I don't understand "carried back...".

I understand that: if I have capital loss of $30,000, then I can claim $3000 every year. And I can carry the loss forward to next 10 years.

[tagteam · Accepted solution]

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@VAer wrote:
Particularly I don't understand "carried back...".

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Carried back simply means you can use the net loss in a prior tax year (i.e., you amend your prior return to include the net loss).

For Section 1256 contracts, that would be up to three prior tax years starting with the earliest tax year in which you have a net Section 1256 gain (i.e., the net loss carryback can only offset 1256 net gains). 

[VAer]

amend prior return?

Let us say, I buy and sell Index Option in 2021 and there is Section 1256 loss, all transactions are done in 2021, can I still amend prior return? I feel like it has nothing to do with prior return.

Thanks.

[tagteam]

Yes, you are allowed to amend a prior return (up to three prior years back) to carry back the net loss.

Note that you have to have a net 1256 gain in one or more of those years. 

[VAer]

Oh, if I just begin trading Index Option this year and had no traded any section 1256 contracts, then there is no need to amend prior return.

In this case, if I have section 1256 contract loss in this year, but no 1256 gain (or absolute no 1256 transaction) in prior three years, how about this year's 1256 loss? There is no way to carry over to future years?

Another example: if I have $7000  section1256 loss this year and $9000 capital gain this year, can I deduct all $7000 from the $9000? So that I only need to pay tax on $2000 capital gain?

Another example: If I have $7000  section1256 loss this year and no other capital gain, but I have W2 salary income, how much can I deduct section 1256 loss? Is it also $3000 per year (just like capital loss)?

Thanks.

[tagteam]

Yes, you can certainly carry any unused loss forward to future tax years. 

With respect to net capital losses, you can use up to $3,000 to offset all of your other income and, of course, capital gains and losses within the same tax year are netted. 

[VAer]

Thanks. Let me be perfectly clear: for section 1256 contract loss, it not only can be carried forward to future year (just like regular capital loss), but also can be carried back three years (if there is section 1256 gain in those three years, just amend that year's return which has section 1256 contract gain, ignore the years which do not have 1256 gain). Is it correct statement?

Another question: If I have section 1256 loss this year and if I have section 1256 gain in last 3 years. If I don't amend the prior returns, can I just carry all section 1256 loss to future years (offset future capital gain)?

Thanks.

[tagteam]

@VAer Both of your statements are correct (questions answered in the affirmative).

[Mike9241]

the net 1256 losses that can be carried back is limited to lesser of the net 1256 losses for the year or your net capital losses for the year reduced by any capital loss deduction.

$50,000 1256 losses for 2020

$30,000 other capital gains

net capital loss $20,000

allowable capital loss deduction $3,000

1256 loss that can be carried back $17,000

40% must be treated as short-term and 60% as longterm 

or

$50,000 1256 losses for 2020

$2,000 other capital losses

net capital loss $52,000

allowable capital loss deduction $3,000

1256 loss that can be carried back $49,000

40% must be treated as short-term and 60% as long-term 

the amount that can be used in a carryback year is the lesser of net Section 1256 gains or net capital gains. 

the carryback cannot create or increase a net operating loss. 

[VAer]

"the amount that can be used in a carryback year is the lesser of net Section 1256 gains or net capital gains"

It can be carried back for previous net capital gains too? So Section 1256 loss is not limited to carried back to offset previous section 1256 gain itself? 

Thanks.

[tagteam]

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@VAer wrote:

It can be carried back for previous net capital gains too? So Section 1256 loss is not limited to carried back to offset previous section 1256 gain itself? 

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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.

See https://www.irs.gov/pub/irs-pdf/f6781.pdf

[DHCLG]

Form 6781 says "Corporations, partnerships, estates, and trusts are not eligible to make this election." (referring to section 1256 carry back.)

So if I read this right, lets say a complex example assumes approx $12,000 in 1256 losses for 2020 with about 7,000 of that in a trust, AND 2019 has less than 4,000 of non-trust 1256 gains, then it sounds like one could choose to do one of the following:

- take the time to amend 2019 with applicable 1256 loss amounts from 2020, and carry forward the rest (including amounts in a trust(?)), or

one could say to one's self "self, it ain't worth the time" and just carry forward the losses (albeit 3K per year), which would include all 1256 losses including those in a trust account(?)

It would be interesting to hear other opinions on this, particularly if I am right in using non-applicable 1256 carry back gains as carry forward losses, and if my trust/non-trust delineations are correct, and finally if one thinks it would be worth one's time.

[fanfare]

don't even think about trusts, they are not eligible for NOL carryback.

Whether it is worthwhile to self depends on whether self wants that potential refund of tax in a prior year.

If you look at what's involved it's a complex calculation and the tax software won't do it for you.

If you make a mistake you will be looking at an IRS audit.

[DHCLG]

Thanks for replying, fanfare!  Appreciate it.

Yeah, It was pretty clear trusts don't apply. I tried to indicate I was aware of that situation in my first sentence, and referring to "applicable amounts" later on.  And thanks for the heads up on TT not doing the calculations; yet another reason for one to think long and hard if they really want to open up the last three years of tax returns (one must go to the oldest return first, if I read the rules right.)

If you multiplied my examples by 10 or 100, I can see it possibly being worth the time, but if I had a situation like that, I would probably just pay a CPA do the work for me.

I'm curious as to if the TT Live CPAs are versed in complex situations like these.  I imagine real estate or business scenarios could get gnarly as well.

[doresearch]

> Another question: If I have section 1256 loss this year and if I have section 1256 gain in last 3 years. If I don't amend the prior returns, can I just carry all section 1256 loss to future years (offset future capital gain)?

I've run into this situation, and want to further clarify something. My tax firm (Dallo Law) said that Section 1256 losses must first be carried back three years in order, and only the unused amount that is not absorbed in years -3 and -2, can be applied to year -1 (previous year). So you can't apply all the Section 1256 loss to the past year, if you've had losses in the two years before it.