Section 1256 Contract loss carryover

[VAer]

I had capital loss on index option (such as SPX option, VIX option) in 2021, and I had never traded section 1256 contract before 2021.

For this year, I rarely trade section 1256 contract anymore, so it is very likely that I will never make capital gain from section 1256 in the future.

Why does it treat Section 1256 Contract Loss differently from stock capital loss?

How does it work? For example, if I had $10,000 stock short term capital loss in 2021 and $10,000 section 1256 contract short term loss (Profit or (loss) realized in 2021 on closed contracts), then if I have $20,000 stock capital short term gain in 2022, can I deduct 2021 section 1256 contract short term loss during next year tax return form?

Anyway, what does below screenshot mean (it is for Section 1256 Contract Loss)? How should I fill it out? It is challenge to file tax return on my own this year, this is my first time dealing with Section 1256 contract.

My understanding is: I can keep this section 1256 loss for future stock capital gain, correct? I don't want amend previous tax return form, which is annoying. Probably I cannot carry it back, since I did not have any trading related to Section 1256 contract, I also claimed $3000 stock capital loss in 2020 tax return already.

How does carry back work? Deduct $3000 from salary income (W2) and reduce $3000 on taxable income?

Or does it carry back to previous year's Section 1256 contract gain only? But I did not have section 1256 contract trade record before 2021.

If I have loss on Section 1256 contract in 2021, even if there was section 1256 contract gain in 2020, can I choose not to carry back (if the gain is small, then I don't want to amend 2020 tax return form)? In stead, I would like to carry Section 1256 contract loss forward? Can section 1256 loss be offset by stock capital gain in the future? I rarely trade section 1256 now.

Thanks.

[GeorgeM777 · Accepted solution]

Section 1256 contracts are taxed differently than equity option contracts.  Section 1256 contracts have lower 60/40 capital gains tax rates which means 60% is subject to lower long-term capital gains rates, and 40% taxed as short-term capital gains using the ordinary rate.  Your other short-term losses will be added to the Section 1256 short-term losses and the same would apply for your long-term losses.  TurboTax will do the calculations for you.   

There is a Section 1256 loss carryback election and that is why you see the screen you included in your post.  If eligible, rather than use the 1256 loss in the current year, you may deduct 1256 losses on an amended prior year tax return; however, the carryback loss can only be applied against Section 1256 gains. Thus, if you don't have any 1256 gains from the prior year, then your only option is to include the loss this year and if you have any losses left over, then carry forward the loss to the next tax year.  

Given your tax situation, you would leave the carryback box blank and continue through the rest of the screens. 

@VAer

[VAer]

@GeorgeM777  Thanks, how does carry forward work? Can the section 1256  loss be offset by future stock capital gain? I don't really trade section 1256 contract anymore.

Thanks.

[Mike9241 · Accepted solution]

there is no differentiation between 1256 loss carryover and capital loss carryover.   so your entire CLCO can be used in 2022 if you have sufficient gains. if not any remaining CLCO goes to 2023

[akrupitsky]

Hello @GeorgeM777,

I've read several threads on related subjects, and I found this one the closest (particularly your answer)  to what I need to understand.

I am confused by the semantics of carryback vs carryover (carry forward). The notion of adjusting old tax return to take advantage of the current year losses seems very weird. Line 5 of form 6781 only mentions carryback but you also mention carry forward the loss to the next tax year. And this is exactly what I need to understand.

In my last year (2021) tax return I had section 1256 losses, in the amount, say, $4,234. I was allowed to deduct only $3,000 from my other income as shown on line 7 of Schedule D while line 6 shows $1,234 of allowed carryback.

In 2022 I had some profits (imagine that!) reported on the same section 1256 and, naturally, I hoped to subtract that "carried back" amount from this years profits but no - there are no offsetting losses on my Schedule D.

There are indications on the web that I need form 1045 but TT doesn't seem to generate it.

So, what should I do?

[GeorgeM777]

Losses realized in connection with Section 1256 contracts can be carried back up to three years.  However, there are limitations to using such losses to offset gains from prior years.  It is also an election, thus, if you did not make that election to carry back the remaining loss amount, then its available for tax year 2022.  

You probably are correct in that the reason you are not seeing the carryover loss on this year's return is because line 6 of Form 6781 reflects that you have elected to carryback your $1,234 loss.  Moreover, box D may also be checked indicating that you have made the election to carry back the loss.   

Go ahead and enter your carryover loss in the section of TurboTax that relates to Capital Loss Carryover.  If you are using TurboTax online, then from Your income and expenses screen, scroll down to Investments and Savings and select Capital Loss Carryover and proceed to enter your information.  In TurboTax CD/download, the process is similar except from the Wages & Income or Personal Income tab, scroll down to Investment Income and select Capital Loss Carryover. 

You might consider amending your 2021 return to change the election on line 6 of Form 6781; however, it is not all that clear that you need to amend.  The IRS recommends that a taxpayer file an amended return when  there's a change in your filing status, income, deductions, credits or tax liability.  The change you are about to make to your 2022 tax return will not change any tax liability, credit, or deduction on your prior year return.  However, out of an abundance of caution, perhaps it's appropriate to amend.

@akrupitsky

[akrupitsky]

Thank you @GeorgeM777 , I did as you advised and TT allowed me to override it. We'll see if it allows me to e-file later.

Admittedly, I made a mistake last year selecting the carryback option. (The IRS and TT could have provided a better guidance but oh well.) I hope I will have a defensible position in case of audit.

[fanfare]

don't use carryback if you don't understand it or are not willing to argue your filing with the IRS.

eventually your loss will be used up in future years without you having to do anything.

[Ray1]

@GeorgeM777 

"however, the carryback loss can only be applied against Section 1256 gains"

Is this something that is practiced commonly, I couldn't find any text talking specifically about the fact that carryback can only be applied to section 1256 gains. On the following guide there is no mention of limitation to section  1256:

"You can elect to carry your net section 1256 contracts loss for 2022 back 3 years. 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 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 for that carryback year."

I'd appreciate your feedback!

[AbrahamT]

So, it says it right here, you can take the smaller of the gains and losses exclusively on the section 1256 trades for that year

(which in essence means the same as saying to take that 1256 carryback loss against 1256 net gain) or the gain if any reported on line 16 of schedule d for that carryback year. Bear in mind that line 16 of schedule d includes not only section 1256 transactions but a host of various gains and losses from capital gains, distributions, 4797 gains, net long term ,short term gain or loss from partnerships, s corps etc. See HERE.

I hope this helps.