Tax Center
What Is the Section 1256 60/40 Rule? A Trader’s Guide
By Owen Monagan ·
The Section 1256 60/40 rule taxes gains and losses on certain regulated contracts as 60% long-term and 40% short-term capital — regardless of how long you held them. Combined with year-end mark-to-market and a three-year loss carryback, it can be friendlier than ordinary income or gambling treatment. Whether prediction-market event contracts qualify is not settled — treat this as a question for a tax professional.
This guide explains what a Section 1256 contract is, how the 60/40 split and mark-to-market work, how it compares to ordinary and gambling treatment, and why traders care — while being clear about what remains an open question. It is information, not tax advice.
What is a Section 1256 contract?
A "Section 1256 contract" is a category defined by the U.S. tax code. Under 26 U.S. Code § 1256, it includes certain regulated futures contracts, foreign currency contracts, nonequity options, dealer equity options, and dealer securities futures contracts — broadly, exchange-traded derivatives that settle through a regulated clearing system.
The label matters because Section 1256 contracts get a distinct tax regime that does not follow the usual "how long did you hold it" capital-gains rules. Two features define that regime: the 60/40 split and mark-to-market.
A key open question for our readers: whether prediction-market event contracts (Kalshi, Polymarket) fall inside this list is not definitively settled. Kalshi is a CFTC-regulated exchange, which is why some traders argue its contracts should be treated like other regulated derivatives — but the IRS and courts have not confirmed that retail event contracts qualify as Section 1256 contracts. We do not assert that they do. We explain the regime so you can ask your tax professional the right question.
How does the 60/40 rule work?
Under the 60/40 rule, any gain or loss on a Section 1256 contract is treated as 60% long-term capital gain or loss and 40% short-term, regardless of your actual holding period. Per the IRS Form 6781, you take the net gain or loss, multiply it by 60% for the long-term portion and 40% for the short-term portion, and carry those to Schedule D.
Why traders like this: long-term capital gains are generally taxed at lower rates than short-term gains (which are taxed at ordinary rates). Because 40% is always treated as short-term and 60% as long-term no matter what, even a position you held for a single day gets the blended rate. For a high-bracket trader, the blended rate can be meaningfully lower than full ordinary treatment.
Here is the math on a $10,000 gain for a top-bracket trader, illustratively using a 37% ordinary rate and a 20% long-term capital-gains rate (your actual rates depend on your full return — this is an example, not a quote of what you owe):
| Treatment | How $10,000 of gain is taxed | Approx. tax in this example |
|---|---|---|
| Section 1256 (60/40) | 60% × 20% LT + 40% × 37% ST = $1,200 + $1,480 | ~$2,680 |
| Ordinary income / gambling | 100% taxed at the 37% marginal rate | ~$3,700 |
| Fully short-term capital | 100% taxed at the 37% short-term (ordinary) rate | ~$3,700 |
The example shows the mechanism, not a promise. The 60/40 blend only helps if the contracts actually qualify for Section 1256 — which, again, is unsettled for event contracts.
What is mark-to-market under Section 1256?
Section 1256 also imposes mark-to-market accounting. Each Section 1256 contract you still hold at year end is treated as if you sold it at fair market value on the last business day of the tax year, per the IRS Form 6781 and Publication 550. Any unrealized gain or loss is recognized for that year, even though you have not actually closed the position. When you do close it later, you adjust for the amount already recognized so you are not taxed twice.
Practically, mark-to-market means there is no "I'll just hold to defer the tax" with a Section 1256 contract — the calendar closes your open positions for you. It also means clean year-end records matter: you need the fair market value of every open position on the last trading day.
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How does Section 1256 compare to ordinary income and gambling treatment?
This is where the characterization question turns into real dollars — especially in a losing year. The same trades can be taxed three very different ways:
| Possible treatment | How gains are taxed | How losses can be used |
|---|---|---|
| Section 1256 (60/40) | Blended 60% long-term / 40% short-term capital, any holding period | Offset capital gains; residual up to $3,000/yr against ordinary income, remainder carried forward; plus a 3-year carryback election against prior Section 1256 gains |
| Ordinary capital gain/loss | Short- or long-term capital rates based on holding period | Offset capital gains, then up to $3,000/yr ordinary income, remainder carried forward |
| Gambling winnings | Ordinary income at your marginal rate | Deductible only up to winnings, and only if you itemize |
Note: the Section 1256 (60/40) row assumes the contracts actually qualify for Section 1256 — which is unsettled for prediction markets. It shows the regime if it applies, not a conclusion that it does.
The $3,000 figure is the §1211(b) cap on net capital losses against ordinary income — it applies to the residual loss after netting, and it is a general capital-loss rule, not a Section 1256 mechanic. Under the gambling framework, a losing year buys you far less. That gap is exactly why the characterization question matters.
How does the Section 1256 loss carryback election work?
Section 1256 has a feature most capital losses don't: a carryback. An individual taxpayer can elect to carry a net Section 1256 contract loss back to each of the three preceding tax years, per the IRS Form 6781 instructions.
The catch is the limit. In a carryback year, the loss can only offset net Section 1256 contract gains reported for that year — it cannot create or increase a net operating loss, and it can't offset other kinds of income. Any loss you can't absorb via carryback is carried forward instead. So the carryback is valuable specifically if you had profitable Section 1256 years recently and a bad year now: you may be able to amend those prior returns and recover tax already paid.
If — and only if — event contracts are treated as Section 1256 contracts, this is the kind of mechanism that could turn a losing year into a refund of prior-year tax. We flag the possibility; we do not assert the treatment applies.
Why does the 60/40 rule matter for prediction-market traders?
Two reasons, both contingent on the unsettled qualification question:
- Winning years could be taxed at a lower blended rate than ordinary income — the 60/40 split pulls 60% of your gain into the lower long-term bracket regardless of holding period.
- Losing years could be worth more than under gambling treatment — capital netting, the $3,000 ordinary offset, the carryforward, and the three-year carryback together can recover real tax, rather than capping you at "losses only up to winnings, if you itemize."
But none of that is automatic. The IRS has not definitively ruled that retail prediction-market event contracts are Section 1256 contracts, and a wrong assumption cuts both ways (mark-to-market can accelerate tax on open winners, too). The right move is to keep records good enough to support whichever treatment your tax professional concludes is correct.
For the bigger picture, see the Prediction Market Tax Center and our related guide on whether Kalshi winnings are taxable.
How Realize helps
Realize connects to your accounts (read-only), pulls your full trade history, and organizes your gains and losses — including the year-end positions that mark-to-market would touch — into a clean, reconciled, year-by-year ledger. That gives you (or your CPA) the numbers needed to apply whatever treatment is correct and to fill out Form 6781 if it applies. Realize does the bookkeeping; the tax characterization is a decision you make with a professional.
The bottom line
The Section 1256 60/40 rule blends a lower long-term rate into every contract, marks open positions to market at year end, and offers a three-year loss carryback — a regime that can be friendlier than ordinary income or gambling treatment. Whether prediction-market event contracts qualify for Section 1256 is unsettled, so treat this as background, keep complete records, and confirm your own situation with a qualified tax professional — ideally a CPA — before filing.