The Tax Implications of Trading Futures
Original post by Wilhelm Schnotz of Demand Media
In the world of investments, most trades are based directly on tangible objects, known as commodities, or shares of companies’ profits, known as securities. Futures traders veer away from such easy distinctions, banking on projected price changes, rather than the value of a security or commodity itself, as the source of their profits. While these trades may exist mostly on the conceptual level, the Internal Revenue Service (IRS) largely treats them as any other capital gains, although it imposes different rules on reporting income from securities futures as commodities futures.
Commodities Futures and Income Taxes
Traders who invest in commodities futures receive slightly different tax treatment than those who invest in other types of assets when the IRS calculates capital gains taxes. Traders report the sale and purchase of commodities sales using Form 6781. Traders must pay a hybrid capital gains tax rate on profits generated by these futures at a rate of 23 percent; 60 percent of gains for commodities futures are taxed at short-term rates of 15 percent, and 40 percent of the gain is treated as a normal short-term gain, and taxed at the rate of 35 percent.
Securities Futures and Income Taxes
Traders who stick to commodities futures enjoy a much more straightforward tax rate, as the IRS treats these trades as it does any other capital gain. As with reporting gains on stocks or real estate values, a securities future trader reports his gains or losses on Schedule D, and pays applicable gains tax rates on it, which is usually 35 for short-term gains because of realization laws. Losses or gains from securities futures may be combined with other assets’ gains and losses. Losses from futures trades may be used to offset gains from traditional trades and vice versa.
Annually Realizing Gains on Futures
The IRS requires traders of commodities and securities futures to realize their gains or losses on each futures contract each tax year, rather than allowing gains and losses to be reported only in the year in which they’re sold. Because of this, traders must file a Schedule D or Form 6781 and report each futures contract as if the contract was executed at the asset’s fair market value on the final day of the year. When the next tax year opens, the future’s basis resets to its fair market value at the first of the year.
Because the IRS requires traders to realize gains and losses on futures contracts at the end of the year, traders may find themselves in a position where they owe gains taxes on securities futures they haven’t sold yet. Some traders employ a strategy of tax selling to help curtail gains taxes on futures. In this strategy, other capital investments that have declined in value are sold simply to incur a loss. This loss then can be used to offset realized gains at the end of the year from unsold futures, and compensate for taxes on unsold assets.
- IRS.gov: Publication 550 - Sales and Trades of Investment Property
- Traders' Log; Futures -- What You Trade Determines How You're Taxed; Jim Forrester
- The Free Dictionary: Tax Straddle
About the Author
Wilhelm Schnotz has worked as a freelance writer since 1998, covering arts and entertainment, culture and financial stories for a variety of consumer publications. His work has appeared in dozens of print titles, including "TV Guide" and "The Dallas Observer." Schnotz holds a Bachelor of Arts in journalism from Colorado State University.