7607 / How is a mixed straddle taxed if there is no election to remove the regulated futures contracts from the mark-to-market tax rules?

If the owner of a mixed straddle does not elect to remove the IRC Section 1256 contract positions from the mark-to-market tax rules, gain or loss on each IRC Section 1256 contract in the straddle is determined under the mark-to-market tax rules (see Q 7583 and Q 7592). Gain or loss on each of the other positions of the straddle is determined under the general tax rules. However, whenever a straddle position is disposed of (or deemed disposed of, as in the case of an IRC Section 1256 contract), the loss deferral, wash sale, and short sale rules of IRC Section 1092 (see Q 7599) are applied to determine whether and in what manner that gain or loss may be recognized for income tax purposes.

The short sale rules that apply to mixed straddles will generally have the effect of recharacterizing short-term losses on non-IRC Section 1256 positions of the mixed straddle as 60 percent long-term and 40 percent short-term.¹ Although the owner of a mixed straddle may avoid this result by making the election to exclude the IRC Section 1256 contracts from the mark-to-market rules, doing so will forfeit the 60/40 percent treatment of gains on the IRC Section 1256 contract positions (see Q 7609). If desirable, it is possible to avoid the loss recharacterization rule while retaining 60/40 percent treatment for mixed straddle net gains derived from IRC Section 1256 contracts by electing to be taxed under the “straddle-by-straddle identification” rules or the “mixed straddle account” rules prescribed by the IRC and defined by regulation.

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Planning Point: Remember, making either of these elections will not avoid the loss deferral and wash sale rules that apply to tax straddles generally.

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A portion of any gain recognized upon disposition, or other termination of a straddle that is part of a conversion transaction (see Q 7616), 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.² See Q 7615 and Q 7616 for the definition and tax treatment of conversion transactions.

While the Internal Revenue Code does not plainly specify the application of the constructive sale rules of IRC Section 1259 to mixed straddles, it apparently is the intent of Congress that mixed straddles under IRC Section 1092(b)(2) will be subject to the rules for constructive sales of an appreciated financial position under IRC Section 1259, generally resulting in immediate gain recognition, the start of a new holding period, and an adjustment to basis (unless certain requirements are met for closing out the constructive sale transaction)³ (see Q 7617 to Q 7621).

The Blue Book states that where either position in such an identified transaction is an appreciated financial position and a constructive sale of that position results from acquiring the second position, Congress intended that the constructive sale would be treated as having occurred immediately before the identified transaction. It adds that the constructive sale will not prevent qualification of the transaction as an identified straddle transaction. It is also the intent of Congress that future regulations will clarify the extent to which straddle transactions will be subject to or excepted from the constructive sale provisions.⁴ Future regulations may clarify the manner in which these rules may be applied to mixed straddles.

Mixed Straddle Accounts