tax straddle

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Tax straddle

Technique used in futures and options trading to create tax benefits. For example, an investor with a capital gain takes a position creating an artificial offsetting loss in the current tax year and postponing a gain from the position until the next tax year.

Tax Straddle

A practice in which two futures or options contracts, one expected to gain and one expected to lose, are sold in two different tax years. The contract expected to lose is sold at the end of one tax year while the one showing a gain is sold at the beginning of the following year. This is done in order to avoid taxation on a futures or option until the following year. This was formerly a common practice until the IRS began to require that all open positions be treated as if they were closed on the last day of the tax year for tax purposes. See also: Form 6781.

tax straddle

A combination of two similar futures contracts (one bought and one sold) that tend to move in opposite directions so that a loss on one is offset by a gain in the other. The contract showing the loss is sold in the current year (shortly before year's end), while the contract showing the gain is sold in the next year. The net effect is to push taxes back one year. This practice ended with legislation that requires all gains and losses in futures contracts to be realized for tax purposes at the end of each year. Compare mark to the market.
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If an investor owns (1) the stock that underlies the put option, (2) stock or securities that are substantially identical to the underlying stock, or (3) other positions that are offsetting with respect to the put option, the purchase of a put may trigger the loss deferral, wash sale, and short sale rules which apply to tax straddles. See Q 7698 to Q 7705 for details.
(1p) See Q 7698 for an explanation of the IRC definition of "offsetting" and Q 7700 for an explanation of the treatment of tax straddles.
Special rules apply in the case of gains or losses of: (1) regulated futures contracts; (2) nonequity option contracts; (3) foreign currency contracts; (4) short sales; (5) wash sales; (6) tax straddles; (7) constructive sales; and (8) constructive ownership transactions.
Also, Congress clearly stated that it did not intend for the section 1256 rules to curtail the use of futures transactions for commercial hedging purposes.(2) In other words, section 1256 was enacted to provide clear timing rules to prevent perceived abuses involving tax straddles by professional commodity traders.
IRC Section 1256 contracts--other than those subject to the special rules for tax straddles (see Q 7701)--must be "marked to the market." Under the mark-to-market tax rules, gains and losses inherent in IRC Section 1256 contracts owned by an investor at the end of the year or at any time during the year must be reported annually, even if those gains or losses have not been realized by the investor.
(Remember, making either of these elections will not avoid the loss deferral and wash sale rules that apply to tax straddles generally.)
See, for example, the rules for tax straddles (Q 7698 to Q 7705).)
(2) See Q 1077 for an explanation of the IRC definition of "offsetting" and Q 1079 for an explanation of the treatment of tax straddles.
IRC Section 1256 contracts--other than those subject to the special rules for tax straddles (see Q 1080)--must be "marked to the market." Under the mark-to-market tax rules, gains and losses inherent in IRC Section 1256 contracts owned by an investor at the end of the year or at any time during the year must be reported annually, even if those gains or losses have not been realized by the investor.
A tax straddle includes offsetting positions for personal property [section 1092(c)(1)].
If a tax straddle is made up solely of regulated futures contracts, foreign currency contracts, and nonequity option contracts (i.e., "IRC Section 1256 contracts"), each contract is generally taxed independently under the mark-to-market tax rules explained in Q 1076, except that if the investor takes delivery under, or exercises, any of the contracts making up the straddle, all the contracts in the straddle are deemed to have been terminated on the day of the delivery or exercise.
If a Treasury bond or note was held as part of a tax straddle, the additional rules and qualifications explained in Q 1077 to Q 1084 apply; if the bond or note was held as part of a conversion transaction, the additional rules discussed in Q 1085 and Q 1086 will apply.