Other Financial Products

Volatility ETNs, swaps, foreign futures, and precious metals.

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

Volatility ETNs are structured as “prepaid forward contracts” or as “debt instruments.” Our tax counsel says that an ETN prepaid forward contract is not considered a security by 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 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 and Section 475 (if elected). ETN debt instruments (i.e., UGAZ) are securities and are 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 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, and ETNs Have Different Structures With Varying Tax Treatment.

In preparing Form 1099-Bs, many brokers use the tax classification determined by exchanges for labeling securities vs. 1256 contracts. Some brokers treat both types of 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 can depart 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 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. Please read our blog post: Tax Treatment for Swaps Options.

Foreign futures. By default, futures contracts listed on international exchanges are not Section 1256 contracts. 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, to see the list of exchanges with this IRS approval.) 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 “collectibles,” which are a particular class of capital assets. If you hold collectibles over one year, sales are taxed at the “collectibles” capital gains tax rate — capped at 28%. That rate is higher than the top regular long-term capital gains rate of 20% (2020 and 2021). (If your ordinary rate is lower than the collectibles rate, then use that.) If you hold collectibles for one year or less, the short-term capital gains ordinary tax rate applies no different from the regular STCG tax rate. Precious metals are not securities, so wash-sale loss adjustments and Section 475 does not apply. Please read our blog post: Tax Treatment for Precious Metals.