Other Financial Products
Foreign futures, precious metals, volatility ETNs, Bitcoin, Nadex binary options, swaps, and deposit losses.
Traders have a bevy of financial products to choose from these days, but unfortunately, the IRS is a bit slow in recognizing innovations in terms of issuing tax guidance. It often waits to see how traders use the new instruments, how they report the transactions on tax returns and how the markets react.
Many foreign brokers promise Americans Section 1256 tax breaks on foreign futures. They mention Commodity Futures Trading Commission (CFTC) “no action letters” granting certain foreign futures exchanges approval for marketing to Americans. These brokers overlook the other requirement: an IRS revenue ruling allowing Section 1256 tax treatment to the foreign futures exchange. There are only a handful of foreign futures exchanges that currently have this IRS revenue ruling. Without Section 1256 treatment, report foreign futures like securities on Form 8949. Read Tax Treatment For Foreign Futures.
Physical precious metals are “collectibles” which are a special class of capital assets. If collectibles are held over one year (long-term), sales are taxed at the “collectibles” tax rate — the taxpayer’s ordinary rate capped at 28%. If collectibles are held one year or less, the short-term capital gains ordinary tax rate applies no different from the regular STCG tax rate. Realized gains and losses in collectibles are reported on Form 8949 and Schedule D along with other capital gains and losses, which means the capital loss limitation of $3,000 against ordinary income applies on individual tax returns. Read Tax Treatment For Precious Metals.
Volatility Products & ETNs
There are many different types of volatility-based financial products to trade, and tax treatment varies. For example, CBOE Volatility Index (VIX) futures are taxed as Section 1256 contracts with lower 60/40 MTM tax rates. The NYSE-traded SVXY is an exchange-traded fund (ETF) taxed as a security.
The iPath S&P 500 VIX Short-Term Futures (VXX) is an exchange-traded note (ETN), and while tax treatment is similar to an ETF, there is uncertain tax treatment on ETNs. The default tax treatment is to treat ETNs as “prepaid forward contracts,” with deferral of taxes until sale (realization) and long-term capital gains rates apply, if held 12 months or longer. In the VXX prospectus, the tax attorneys mentioned an “alternative tax treatment” looking through the ETN to the underlying Section 1256 contract treatment based on IRS revenue ruling 2008-1. (Consult a tax advisor as this alternative tax treatment is uncertain.)
Options on VXX are listed on the CBOE and are likely considered non-equity options with Section 1256 treatment. Read our blog post: Tax Treatment For Volatility Products Including ETNs. Read Tax Treatment For Volatility Products Including ETNs.
The IRS was late issuing guidance stating bitcoin is an “intangible asset” for investors and traders. That’s good news on some fronts as it allows lower long-term capital gains tax rates (up to 20% for 2016) on realized trades held over 12 months. But investors who bought high may have losses and capital loss limitations will apply. Before the IRS acted, we argued that perhaps a trader could consider Bitcoin a digital currency and use Section 988 forex ordinary loss treatment. But, that’s not possible with the IRS guidance. As an intangible asset, use the realization method as with securities. That means you don’t report unrealized gains and losses. Read IRS Guidance On Bitcoin Transactions.
Nadex binary options
North American Derivatives Exchange (Nadex) offers binary options trading. While the IRS hasn’t delivered guidance on binary options yet, Nadex issued Form 1099-Bs (for 2015 and prior years) with coveted Section 1256 tax treatment (with lower 60/40 tax rates). We did extensive tax research on binary options, and we tend to disagree with Nadex. We think Nadex binary options may require ordinary gain or loss treatment like swap and forex tax treatment. Tax treatment on Nadex is unclear so consult us about it. If you have a large loss, you may prefer to use ordinary loss treatment rather than have a capital loss limitation with Section 1256 treatment. Read Tax Treatment For Nadex Binary Options.
The Dodd-Frank financial regulation law promised to clear private swap transactions on exchanges to protect the markets from another swap-induced financial meltdown — remember those credit default swaps with insufficient margin? When Dodd-Frank was enacted, traders’ hoped that clearing on futures exchanges would allow Section 1256 tax treatment. They were wrong: Congress and the IRS immediately communicated that Section 1256 would not apply to swap transactions, and they confirmed ordinary gain or loss treatment. Read Tax Treatment for Swaps, Options On Swaps, Futures Swaps, And Options On ETFs Partially Consisting Of Swaps.
For in-depth information on tax treatment for the above financial instruments, read Green’s 2017 Trader Tax Guide