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Long term Capital Gain treatment for assets held less than 1 year?

Were you aware that some investments will provide you with partial long term capital gain when only held for a day?  IRC § 1256 Gains will do just that.capital-gains-IRC1256

Qualifying IRC § 1256 gains are split between long term and short term capital gains treatment. Sixty percent of the gain (loss) is treated as long term and 40% as short term.  This could result in big savings.  If you’re in the 25%, 28%, 33% or 35% tax bracket, then your long term capital gains tax rate is a preferential 15%.  If you’re in the highest bracket of 39.6%, then your long term capital gains rate topped at 20%.   Think of the savings in taxes.

Here’s an example:

Let’s say you bought and sold shares of a US company and held those shares for two months.   Let’s assume your short-term gain was $10,000 and your effective tax rate is 35%, your tax on the gain would be:

$10,000 X 35% = $3,500 (short term gains are taxed at your effective tax rate)

Now, instead of a short term gain on a normal stock, let’s assume you have $10,000 gain from a qualifying IRC § 1256 transaction, your tax on the gain would be:

($4,000 X 35%) + ($6,000 X 15%) = $2,300 (40% of gain is taxed at effective tax rate and 60% of gain is taxed based on long term capital gains rate)

The IRC § 1256 gain would net you a tax savings of $1,200.

An  IRC § 1256 contract or investment is defined in the simplest terms as:

  • Regulated futures contracts
  • Foreign currency contracts
  • Non-equity options
  • Dealer equity options
  • Dealer securities futures contract

Reporting of IRC § 1256 gains and losses can be complex and cumbersome but this also depends on the broker you are using and the tax information they provide.  Unlike ordinary capital gains and losses, which are reported on IRS form 8949 and flow to Schedule D on your form 1040, IRC § 1256 reporting goes on IRS Form 6787 “Gains and Losses from Section 1256 Contracts and Straddles”.   It is also important to note that Mark to Market (M to M) rules apply to IRC § 1256 investments that are held at year-end.  M to M reporting treats your investment as if it were sold at fair market value (FMV) on the last business day of the year.  The deemed gain or loss per the M to M rules is reported on your tax return and the new cost basis is carried forward into the next tax season.  There are other aspects of the IRC § 1256 investments that should be considered. For example, you may carry back losses from IRC § 1256 investments (assuming there have been IRC § 1256 gains in the prior year) for up to three years.

You must also consider the recently imposed “net investment tax”.  This 3.8% tax is imposed on your net investment income if you have Net Investment Income and also have modified adjusted gross income over the following thresholds:
Long term Capo gain blog post Feb 2016

 

 

If you are interested in this type of investment, you should consult your financial advisor for more information to determine if this type of investment makes sense for you. You can also consult US Tax and Financial Services to fully understand the tax implications applicable to you for this type of investment.

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