7604 / How is a tax straddle taxed if made up solely of Section 1256 contracts?

A tax straddle made up solely of IRC Section 1256 contracts is excepted from the loss deferral, wash sale, and short sale rules of IRC Section 1092 and the capitalization provisions of IRC Section 263(g). See Q 7599 for an explanation of those rules.²

A portion of any gain recognized upon disposition or other termination of a straddle that is part of a conversion transaction (see Q 7615) may be treated as ordinary income. A straddle will be subject to these rules if substantially all of the taxpayer’s expected return from the investment is attributable to the time value of the taxpayer’s net investment in the transaction.³ See Q 7615 and Q 7616 for the definition and tax treatment of conversion transactions.

Although IRC Section 1256 contracts are excluded from the definition of an appreciated financial position under IRC Section 1259(b)(2)(B) (see Q 7617), depending on the taxpayer’s other holdings, it appears that a constructive sale could result from entering into an IRC Section 1256 contract to deliver property that is the same as or substantially identical to an appreciated financial position held by the taxpayer (see Q 7617 to Q 7621).⁴