Tag Archives: deposit losses

Tax Treatment Of Forex Losses In Wake Of Swiss Surprise

January 17, 2015 | By: Robert A. Green, CPA

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If you are one of many who got caught on the wrong side of the forex trade when the Swiss National Bank (SNB) surprised the markets with a huge policy change this week, you probably incurred significant losses. Here’s a quick primer on how to handle these losses on your tax returns.

First, it’s important to segregate your losses into two camps: the forex trading loss (Section 988 or capital loss) incurred on your open positions that were liquidated or closed by you or your broker, versus losing a deposit in an insolvent financial institution (Section 165). The latter also happened to traders who made money on this market event.

Forex tax treatment
By default, forex trading losses are Section 988 ordinary losses, unless you filed an internal contemporaneous capital gains election at any time before this new trading loss was incurred. In that case, it’s a capital loss subject to capital loss limitations of $3,000 per year against ordinary income. With a capital gains election in place, if you trade major currencies and don’t take or make delivery, you probably use Section 1256(g) lower 60/40 capital gains rates.

If you qualify for trader tax status (business treatment), Section 988 losses are business losses includible in net operating loss carry backs and forwards. But without trader tax status, you’ll need other income to absorb the forex ordinary loss, because the negative income part is otherwise wasted. If you’re using Section 1256(g), you can file a net Section 1256 loss carry back election for 2015 to carry the loss back three years to offset Section 1256 gains in those years. (Read more about forex tax treatment in our Trader Tax Center).

Deposit loss tax treatment
Hopefully, other banks and brokers will rescue teetering forex brokers and not too many forex traders will lose their deposits in insolvent financial institutions. That would be unfortunate since there is no FDIC or SIPIC money-protection on forex accounts. If U.S. and foreign forex brokers fail, hopefully the firms have private insurance that pays out the deposit holders in full for their deposit losses. If there is less than full recovery of deposit losses through insurance or otherwise, sustained losses are subject to Section 165 tax treatment.

We addressed similar issues when we covered the MF Global insolvency and recovery efforts over the past few years.

Excerpt from our Trader Tax Center
Many investors, traders and hedge funds got sideswiped by the MF Global and PFG bankruptcies over the past few years. Unfortunately, futures and forex account holders are not afforded government protection like bank account holders with FDIC protection and securities account holders with SIPIC protection. Tax treatment is far better when the IRS declares the loss a “theft loss”and allows application of IRS Revenue Procedure 2009-20, originally enacted to provide tax relief for investors in the Bernie Madoff Ponzi scheme. Theft losses receive ordinary loss treatment plus acceleration of losses on tax returns. Otherwise, Section 165 applies to deposit losses in insolvent financial institutions like MF Global. Investors are stuck choosing between capital loss treatment, which may trigger capital loss limitations, or itemized deduction treatment with various restrictions and haircuts. Business traders with trader tax status benefit from business ordinary loss treatment. Taxpayers with Section 165 losses must wait for the loss to be “sustained”so trustees have ample time for fund recovery. MF Global futures account holders recovered their losses in full, although forex account holders may have some sustained losses. (Read our blogs, PFG investors can deduct theft losses on 2012 tax returns with Rev. Proc. 2009-20 safe harbor relief, and MF Global & PFG Best deposit losses have nuanced tax treatment.)

I imagine bankruptcy trustees for these failing forex brokers will seek to recover funds from customers who incurred forex trading losses in excess of their deposits, unless the account agreements say otherwise. I also envision there will be arguments over who bears responsibility for excess losses, the broker or customer in cases where brokers liquidated positions and sometimes too late.

Disregard of CFTC rules
Many American forex traders disregarded CFTC rules (for retail off-exchange forex) by trading with non-registered offshore brokers offering leverage far above CFTC limits of 50:1 on major currencies and 20:1 on minor currencies. Several offshore brokers and a few U.S.-based forex brokers are facing financial strain or insolvency as a result of offering excess leverage to their customers during the SNB shockwave. When markets are extremely volatile the broker and customer may not be able to exit a trade before incurring a significant loss well in excess of the customer’s deposit amount. Let’s see how the money protection issue works out offshore.

Other Financial Products

August 29, 2014 | By: Robert A. Green, CPA

Volatility ETNs. There are many volatility-based financial products to trade, and tax treatment varies. For example, CBOE Volatility Index (VIX) futures are Section 1256 contracts with lower 60/40 MTM tax rates. The NYSE-traded SVXY is an ETF taxed as a security.

Volatility exchange-traded notes (ETN) are structured as “prepaid forward contracts” or as “debt instruments.” Our tax counsel says that an ETN prepaid forward contract is not a security in the eyes of the IRS, whereas ETN debt instruments are.

Sales of ETN prepaid forward contracts use the realization method on sales. Long-term capital gains rates apply if held for 12 months or longer. Because it’s not a security, ETN prepaid forward contracts (i.e., VXX) are not subject to wash-sale loss adjustments or Section 475 (if elected). ETN debt instruments (i.e., UGAZ) are securities subject to wash-sale losses and Section 475 (if elected). Check the tax section of the ETN prospectus.

There is substantial authority to treat CBOE-listed options on volatility ETNs and on volatility ETFs structured as publicly traded partnerships as “non-equity options” with Section 1256 treatment. See our blogs: How To Apply Lower Tax Rates To Volatility Options (https://tinyurl.com/volatility-option), and ETNs Have Different Structures With Varying Tax Treatment (https://tinyurl.com/gtt-etns).

In preparing Form 1099-Bs, many brokers use the tax classification determined by exchanges for labeling securities vs. 1256 contracts. Some brokers treat both ETNs as securities on 1099-Bs with wash-sale loss adjustments, even though prepaid forward contracts do not fall in that category. Some brokers treat CBOE-listed options on volatility ETNs and ETF PTPs as securities on Form 1099-Bs, even though they are eligible for Section 1256 treatment. Taxpayers should consider departing from 1099-Bs based on substantial authority positions and explain why in a tax return footnote.

Swap contracts. 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 margins? When Congress enacted Dodd-Frank in 2010, 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. Please read our blog post: Tax Treatment for Swaps Options, https://tinyurl.com/gtt-swaps.

Foreign futures. By default, futures contracts listed on international exchanges are not Section 1256. If the international exchange wants Section 1256 tax treatment, it must obtain an IRS Revenue Ruling. Only a handful of international futures exchanges have Section 1256 treatment: Eurex, LIFFE, ICE Futures Europe, and ICE Futures Canada. Foreign futures are otherwise ST or LT capital gains. (Read our blog Tax Treatment for Foreign Futures https://tinyurl.com/ttfutures to see the list of exchanges with this IRS approval and Updated 2021 US IRC Section 1256 qualified board or exchange list.) Remember, Section 1256 tax treatment uses MTM accounting at year-end. Foreign futures without Section 1256 are reported like securities using the realization method for short- vs. long-term capital gains.

Precious metals. Physical precious metals are a particular class of capital assets called collectibles. If you hold collectibles over 12 months before the sale, you must use the collectibles capital gains tax rate — capped at 28%. That rate is higher than the top long-term capital gains rate of 20% (2022 and 2023). The short-term capital gains rate applies if you hold collectibles for 12 months or less. Precious metals are not securities, so wash-sale loss adjustments and Section 475 do not apply. Please read our blog post: Tax Treatment for Precious Metals, https://tinyurl.com/gtt-precious.

For more information, see Green’sTrader Tax Guide Chapter 3 Tax Treatment of Financial Products.