The following is for informational purposes only. ALTAVRA does not offer tax advice. Please contact a professional tax accountant for tax advice.  The following text defines section 1256 contacts according to Cornell University Law School referenced by the United States Internal Revenue Service's WEBSITE; SECTION: Tax Code, Regulations and Guidance (http://www.irs.gov/taxpros/article/0,,id=98137,00.html).

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(a) General rule
For purposes of this subtitle—
(1) each section 1256 contract held by the taxpayer at the close of the taxable year shall be treated as sold for its fair market value on the last business day of such taxable year (and any gain or loss shall be taken into account for the taxable year),

(2) proper adjustment shall be made in the amount of any gain or loss subsequently realized for gain or loss taken into account by reason of paragraph (1),
 

(3) any gain or loss with respect to a section 1256 contract shall be treated as—
    (A) short-term capital gain or loss, to the extent of 40 percent of such gain or loss, and
    (B) long-term capital gain or loss, to the extent of 60 percent of such gain or loss, and
 

(4) if all the offsetting positions making up any straddle consist of section 1256 contracts to which this section applies (and such straddle is not part of a larger straddle), sections 1092 and 263 (g) shall not apply with respect to such straddle.
 

(b) Section 1256 contract defined
(1) In general
For purposes of this section, the term “section 1256 contract” means—
    (A) any regulated futures contract,
    (B) any foreign currency contract,
    (C) any non-equity option,
    (D) any dealer equity option, and
    (E) any dealer securities futures contract.

(2) Exceptions
The term “section 1256 contract” shall not include—
    (A) any securities futures contract or option on such a contract unless such contract or option is a dealer securities

    futures contract, or
    (B) any interest rate swap, currency swap, basis swap, interest rate cap, interest rate floor, commodity swap, equity

    swap, equity index swap, credit default swap, or similar agreement.
   

(c) Terminations, etc.
(1) In general
The rules of paragraphs (1), (2), and (3) of subsection (a) shall also apply to the termination (or transfer) during the taxable year of the taxpayer’s obligation (or rights) with respect to a section 1256 contract by offsetting, by taking or making delivery, by exercise or being exercised, by assignment or being assigned, by lapse, or otherwise.

(2) Special rule where taxpayer takes delivery on or exercises part of straddle

    If—
    (A) 2 or more section 1256 contracts are part of a straddle (as defined in section 1092 (c)), and
    (B) the taxpayer takes delivery under or exercises any of such contracts, then, for purposes of this section, each of the

    other such contracts shall be treated as terminated on the day on which the taxpayer took delivery.

(3) Fair market value taken into account
For purposes of this subsection, fair market value at the time of the termination (or transfer) shall be taken into account.
 

(d) Elections with respect to mixed straddles
(1) Election
The taxpayer may elect to have this section not to apply to all section 1256contracts which are part of a mixed straddle.

(2) Time and manner
An election under paragraph (1) shall be made at such time and in such manner as the Secretary may by regulations prescribe.
 

(3) Election revocable only with consent
An election under paragraph (1) shall apply to the taxpayer’s taxable year for which made and to all subsequent taxable years, unless the Secretary consents to a revocation of such election.
 

(4) Mixed straddle
For purposes of this subsection, the term “mixed straddle” means any straddle (as defined in section 1092 (c))—
    (A) at least 1 (but not all) of the positions of which are section 1256contracts, and
    (B) with respect to which each position forming part of such straddle is clearly identified, before the close of the day on

    which the first section 1256contract forming part of the straddle is acquired (or such earlier time as the Secretary may

    prescribe by regulations), as being part of such straddle.
 

(e) Mark to market not to apply to hedging transactions
(1) Section not to apply
Subsection (a) shall not apply in the case of a hedging transaction.
 

(2) Definition of hedging transaction
For purposes of this subsection, the term “hedging transaction” means any hedging transaction (as defined in section 1221 (b)(2)(A)) if, before the close of the day on which such transaction was entered into (or such earlier time as the Secretary may prescribe by regulations), the taxpayer clearly identifies such transaction as being a hedging transaction.
 

(3) Special rule for syndicates
    (A) In general
    Notwithstanding paragraph (2), the term “hedging transaction” shall not include any transaction entered into by or for a

    syndicate.
    (B) Syndicate defined
    For purposes of subparagraph (A), the term “syndicate” means any partnership or other entity (other than a corporation

    which is not an S corporation) if more than 35 percent of the losses of such entity during the taxable year are allocable

    to limited partners or limited entrepreneurs (within the meaning of section 464 (e)(2)).
    (C) Holdings attributable to active management
    For purposes of subparagraph (B), an interest in an entity shall not be treated as held by a limited partner or a limited

    entrepreneur (within the meaning of section 464 (e)(2))—
        (i) for any period if during such period such interest is held by an individual who actively participates at all times

        during such period in the management of such entity,
        (ii) for any period if during such period such interest is held by the spouse, children, grandchildren, and parents of an

        individual who actively participates at all times during such period in the management of such entity,
        (iii) if such interest is held by an individual who actively participated in the management of such entity for a period of

        not less than 5 years,

        (iv) if such interest is held by the estate of an individual who actively participated in the management of such entity

        or is held by the estate of an individual if with respect to such individual such interest was at any time described in

        clause (ii), or
        (v) if the Secretary determines (by regulations or otherwise) that such interest should be treated as held by an

        individual who actively participates in the management of such entity, and that such entity and such interest are not

        used (or to be used) for tax–avoidance purposes.
    For purposes of this subparagraph, a legally adopted child of an individual shall be treated as a child of such individual

    by blood.
 

(4) Limitation on losses from hedging transactions
    (A) In general
        (i) Limitation Any hedging loss for a taxable year which is allocable to any limited partner or limited entrepreneur

        (within the meaning of paragraph (3)) shall be allowed only to the extent of the taxable income of such limited

        partner or entrepreneur for such taxable year attributable to the trade or business in which the hedging transactions

        were entered into. For purposes of the preceding sentence, taxable income shall be determined by not taking into

        account items attributable to hedging transactions.
        (ii) Carryover of disallowed loss Any hedging loss disallowed under clause (i) shall be treated as a deduction

        attributable to a hedging transaction allowable in the first succeeding taxable year.
    (B) Exception where economic loss
    Subparagraph (A)(i) shall not apply to any hedging loss to the extent that such loss exceeds the aggregate

    unrecognized gains from hedging transactions as of the close of the taxable year attributable to the trade or business

    in which the hedging transactions were entered into.

    (C) Exception for certain hedging transactions
    In the case of any hedging transaction relating to property other than stock or securities, this paragraph shall apply

    only in the case of a taxpayer described in section 465 (a)(1).
    (D) Hedging loss
    The term “hedging loss” means the excess of—
    (i) the deductions allowable under this chapter for the taxable year attributable to hedging transactions (determined

    without regard to subparagraph (A)(i)), over
    (ii) income received or accrued by the taxpayer during such taxable year from such transactions.
    (E) Unrecognized gain
    The term “unrecognized gain” has the meaning given to such term by section 1092 (a)(3).
 

(f) Special rules
(1) Denial of capital gains treatment for property identified as part of a hedging transaction
For purposes of this title, gain from any property shall in no event be considered as gain from the sale or exchange of a capital asset if such property was at any time personal property (as defined in section 1092 (d)(1)) identified under subsection (e)(2) by the taxpayer as being part of a hedging transaction.
 

(2) Subsection (a)(3) not to apply to ordinary income property
Paragraph (3) of subsection (a) shall not apply to any gain or loss which, but for such paragraph, would be ordinary income or loss.
 

(3) Capital gain treatment for traders in section 1256 contracts
    (A) In general
    For purposes of this title, gain or loss from trading of section 1256contracts shall be treated as gain or loss from the

    sale or exchange of a capital asset.
    (B) Exception for certain hedging transactions
    Subparagraph (A) shall not apply to any section 1256 contract to the extent such contract is held for purposes of

    hedging property if any loss with respect to such property in the hands of the taxpayer would be ordinary loss.

    (C) Treatment of underlying property
    For purposes of determining whether gain or loss with respect to any property is ordinary income or loss, the fact that

    the taxpayer is actively engaged in dealing in or trading section 1256 contracts related to such property shall not be

    taken into account.
 

(4) Special rule for dealer equity options and dealer securities futures contracts of limited partners or limited

entrepreneurs
In the case of any gain or loss with respect to dealer equity options, or dealer securities futures contracts, which are allocable to limited partners or limited entrepreneurs (within the meaning of subsection (e)(3))—
    (A) paragraph (3) of subsection (a) shall not apply to any such gain or loss, and
    (B) all such gains or losses shall be treated as short-term capital gains or losses, as the case may be.
 

(5) Special rule related to losses
Section 1091 (relating to loss from wash sales of stock or securities) shall not apply to any loss taken into account by reason of paragraph (1) of subsection (a).

(g) Definitions
For purposes of this section—
(1) Regulated futures contracts defined
The term “regulated futures contract” means a contract—
    (A) with respect to which the amount required to be deposited and the amount which may be withdrawn depends on a

    system of marking to market, and
    (B) which is traded on or subject to the rules of a qualified board or exchange.
 

(2) Foreign currency contract defined
    (A) Foreign currency contract
    The term “foreign currency contract” means a contract—
        (i) which requires delivery of, or the settlement of which depends on the value of, a foreign currency which is a

        currency in which positions are also traded through regulated futures contracts,
        (ii) which is traded in the interbank market, and
        (iii) which is entered into at arm’s length at a price determined by reference to the price in the interbank market.
    (B) Regulations
    The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of

    subparagraph (A), including regulations excluding from the application of subparagraph (A) any contract (or type of

    contract) if its application thereto would be inconsistent with such purposes.
 

(3) Non-equity option
The term “nonequity option” means any listed option which is not an equity option.
 

(4) Dealer equity option
The term “dealer equity option” means, with respect to an options dealer, any listed option which—
    (A) is an equity option,
    (B) is purchased or granted by such options dealer in the normal course of his activity of dealing in options, and
    (C) is listed on the qualified board or exchange on which such options dealer is registered.
 

(5) Listed option
    The term “listed option” means any option (other than a right to acquire stock from the issuer) which is traded on (or

    subject to the rules of) a qualified board or exchange.
 

(6) Equity option
    The term “equity option” means any option—
    (A) to buy or sell stock, or
    (B) the value of which is determined directly or indirectly by reference to any stock or any narrow-based security index

    (as defined in section 3(a)(55) of the Securities Exchange Act of 1934, as in effect on the date of the enactment of this

    paragraph).
    The term “equity option” includes such an option on a group of stocks only if such group meets the requirements for a

    narrow-based security index (as so defined). The Secretary may prescribe regulations regarding the status of options

    the values of which are determined directly or indirectly by reference to any index which becomes (or ceases to be) a

    narrow-based security index (as so defined).
 

(7) Qualified board or exchange
The term “qualified board or exchange” means—
    (A) a national securities exchange which is registered with the Securities and Exchange Commission,
    (B) a domestic board of trade designated as a contract market by the Commodity Futures Trading Commission, or
    (C) any other exchange, board of trade, or other market which the Secretary determines has rules adequate to carry

    out the purposes of this section.
 

(8) Options dealer
    (A) In general
    The term “options dealer” means any person registered with an appropriate national securities exchange as a market

    maker or specialist in listed options.
    (B) Persons trading in other markets
    In any case in which the Secretary makes a determination under subparagraph (C) of paragraph (7), the term “options

    dealer” also includes any person whom the Secretary determines performs functions similar to the persons described

    in subparagraph (A). Such determinations shall be made to the extent appropriate to carry out the purposes of this

    section.
 

(9) Dealer securities futures contract
    (A) In general
    The term “dealer securities futures contract” means, with respect to any dealer, any securities futures contract, and

    any option on such a contract, which—
        (i) is entered into by such dealer (or, in the case of an option, is purchased or granted by such dealer) in the normal

        course of his activity of dealing in such contracts or options, as the case may be, and
        (ii) is traded on a qualified board or exchange.
    (B) Dealer
    For purposes of subparagraph (A), a person shall be treated as a dealer in securities futures contracts or options on

    such contracts if the Secretary determines that such person performs, with respect to such contracts or options, as

    the case may be, functions similar to the functions performed by persons described in paragraph (8)(A). Such

    determination shall be made to the extent appropriate to carry out the purposes of this section.
    (C) Securities futures contract
    The term “securities futures contract” has the meaning given to such term by section 1234B.

THE RISK OF LOSS IN TRADING FUTURES, OPTIONS AND OFF-EXCHANGE FOREX CAN BE SUBSTANTIAL.  PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.  PLEASE READ THE CTA'S RISK DISCLOSURE DOCUMENT CAREFULLY BEFORE INVESTING MONEY.