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How FOREX Trades Are Taxed

For beginners in the foreign exchange markets (FOREX), the goal is simply to make successful trades. In a market where profits and losses can be realized in the blink of an eye, many just want to try their hand before thinking long-term. Nevertheless, there’s good reason to consider the tax implications before making that first trade.

For Options and Futures Investors

For Over-the-Counter (OTC) Investors

If you trade spot FOREX you will likely be grouped in this category as a “988 trader.” If you experience net losses through your year-end trading, being categorized as a “988 trader” is a substantial benefit. As in the 1,256 contract category, you can count all of your losses as “ordinary losses,” not just the first $3,000.

Which Contract to Choose

Now comes the tricky part: Deciding how to file taxes for your situation. While options or futures and OTC are grouped separately, the investor can pick either a 1256 or 988 contract.

The significant difference between the two is that of anticipated gains and losses. But you must decide which you will use by the first day of the calendar year.

IRC 988 contracts are simpler than IRC 1256 contracts. The tax rate remains constant for both gains and losses, an ideal situation for losses.

Notably, 1256 contracts, while more complex, offer 12% more savings for a trader with net gains.

Most accounting firms use 988 contracts if you are a spot trader and 1256 contracts if you are a futures trader. That’s why it’s important to talk with your accountant before investing. Once you begin trading, you cannot switch from one to the other.

Most traders naturally anticipate net gains, so they will want to elect out of their 988 status and into 1256 status. To opt out of a 988 status you need to make an internal note in your books as well as file the change with your accountant.

This complication intensifies if you trade stocks as well as currencies. Equity transactions are taxed differently, and you may not be able to elect 988 or 1256 contracts.

Keeping Track

This is an IRS-approved formula for record keeping:

The performance record formula will give you a more accurate depiction of your profit/loss ratio and will make year-end filing easier for you and your accountant.

Things to Remember

The Bottom Line

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About Amy Harvey

Amy R. Harvey writes forStartUps Sections In AmericaRichest.

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