IRC Section 988: Forex Gains, 60/40 Election, and Reporting

Under IRC Section 988, foreign currency gains and losses are treated as ordinary income by default, taxed at the same federal rates as wages rather than at capital gains rates.¹ That default can work for or against you: ordinary rates run as high as 37%, but ordinary losses aren’t capped at $3,000 the way capital losses are, so a bad year on currency positions can offset your other income in full. For forward contracts, futures, and options tied to foreign currency, you can elect out of ordinary treatment and into capital gains treatment, but only if you jump through some very specific hoops on the day the trade is entered.

Which Transactions Section 988 Covers

Three kinds of activity fall under these rules. Disposing of a nonfunctional currency itself is the first: if you hold euros in a bank account and convert them back to dollars at a different exchange rate than when you acquired them, that conversion is a taxable event.¹

Second, entering into or acquiring forward contracts, futures contracts, options, or similar financial instruments tied to foreign currency values triggers the rules.¹ This is the category most forex traders live in.

Third, the rules reach any accrued income or expense that will be paid or received in a foreign currency at a later date.¹ A company that invoices a client in British pounds in October but doesn’t collect until January has a Section 988 event if the exchange rate shifts between those dates. The gain or loss is created by the timing gap, not by any decision to speculate.

Section 988 only applies when a transaction involves a “nonfunctional currency.” For individual U.S. taxpayers, the functional currency is almost always the dollar, so any other currency you touch is nonfunctional. Two things Section 988 does not cover deserve mention up front. Cryptocurrency is not foreign currency: the IRS classifies virtual currency as property, distinct from “real currency” denominated in a government’s currency, so crypto gains and losses follow the capital gains rules for property, not Section 988.² And personal losses (say, on vacation money left over after a trip) generally aren’t deductible at all.

Why Ordinary Treatment Often Works in Your Favor

The baseline rule is simple: any gain or loss from a Section 988 transaction is ordinary.¹ Currency profits get taxed at federal rates from 10% to 37%, the same brackets that apply to wages and business income.³

The real payoff shows up on the loss side. Capital losses are limited to a net $3,000 deduction against ordinary income per year, with the rest carried forward.⁴ Ordinary losses face no such cap. A trader who loses $40,000 on currency positions in a single year can use that entire loss to reduce wages, interest income, or business profits on the same return. For anyone who expects net losses from currency exposure, the default is the better deal.

The Capital Gains Election for Forwards, Futures, and Options

Taxpayers who expect gains rather than losses have a reason to escape ordinary treatment: long-term capital gains are taxed at 0%, 15%, or 20% depending on income, which can be dramatically lower than ordinary rates.⁴ Section 988(a)(1)(B) lets you elect capital treatment for certain foreign currency positions.

The election is narrower than many traders realize. It applies only to forward contracts, futures contracts, and options involving foreign currency. It does not apply to the disposition of foreign currency itself or to accrued income and expense items. Two additional conditions must be met: the contract must be a capital asset in your hands, and it cannot be part of a straddle.¹

Even when the election applies, holding period still matters. A forward contract held for six months produces short-term capital gain, which is taxed at ordinary rates anyway. The election only pays off if you hold the position for more than a year.

The Same-Day Identification Rule

The election must be made before the close of the day the transaction is entered into. Treasury regulations require you to clearly identify the transaction on your books and records that same day. No specific language or account is required, but the identification method must be applied consistently and must clearly mark the transaction as subject to the Section 988(a)(1)(B) election. The IRS retains discretion to invalidate any election that doesn’t meet this standard.⁵

There’s a second step that catches people off guard. At tax time, you must attach a statement to your return that includes a description and date of each election made during the year, a confirmation that each election was made before the close of the day the transaction was entered into, a description of any contract that expired or was sold during the year, and a declaration that the contract was never part of a straddle.⁵ A same-day memo in your files is only half the job. Skipping the return statement gives the IRS an easy basis to throw the election out.

Section 1256: A 60/40 Alternative for Some Forex Contracts

A separate provision, IRC Section 1256, offers a different treatment for a specific subset of foreign currency contracts. Qualifying contracts are marked to market at year-end and any gain or loss is split 60% long-term capital gain and 40% short-term capital gain, regardless of how long the position was actually held.⁶ At the top capital gains rate of 20%, this blend produces a maximum effective rate well below the 37% top ordinary rate.

To qualify, a foreign currency contract must require delivery of (or settlement based on the value of) a currency in which regulated futures contracts also trade, be traded in the interbank market, and be entered into at arm’s length at a price set by reference to interbank pricing.⁶ Many over-the-counter spot forex contracts traded through retail platforms do not clearly meet these criteria, which is why this area generates so much confusion among traders.

Section 988 generally takes priority over Section 1256 for foreign currency transactions. Hedging transactions under Section 988(d), for example, explicitly override Section 1256.⁷ The interaction between the two sections is genuinely complex, and choosing the wrong treatment can result in both back taxes and penalties. Anyone dealing in significant forex volume should work through this with a tax professional.

The $200 Personal-Use Exemption for Travelers

Individual taxpayers get a narrow break for personal foreign currency transactions. Under Section 988(e), if you buy foreign currency for personal use and the exchange rate moves in your favor before you spend it, no gain is recognized as long as the gain stays at or below $200.¹ The classic case: exchanging dollars for euros before a trip, then spending those euros after the euro has strengthened.

Two limits keep this exemption narrow. “Personal transaction” means expenses not connected to a trade or business and not incurred to produce investment income. A freelancer who invoices in foreign currency or an investor holding currency as a speculation cannot use it. And if the gain tops $200, the entire amount is taxable under the standard Section 988 rules, not just the portion above $200.¹

How to Report It

The right form depends on which treatment applies. Under the default ordinary treatment, gains and losses are reported on Form 1040, typically on Schedule 1 as other income or as an adjustment.⁸

If you made a valid capital gains election, you report each transaction on Form 8949 with the totals flowing to Schedule D, and attach the election statement to the same return.⁸ Section 1256 contracts go on Form 6781 instead.

Exchange Rate Sources

Every calculation requires an exchange rate, and using the wrong source can create problems. The IRS says to use the exchange rate prevailing on the day you receive, pay, or accrue the item, and if multiple rates are available, to use the one that most properly reflects your income. Government sources the IRS references include the Treasury Department’s published rates and the Federal Reserve Bank; external sources include Oanda.com and xe.com.⁹ Whichever source you pick, use it consistently through the year. Switching sources mid-year to cherry-pick favorable rates is exactly the kind of thing that draws attention on audit.

A Note on Foreign Account Reporting

Holding foreign currency in overseas accounts can trigger reporting duties that sit outside Section 988 but catch many of the same taxpayers. If the combined value of all your foreign financial accounts exceeds $10,000 at any point during the year, you must file FinCEN Form 114 (the FBAR) by April 15, with an automatic extension to October 15.¹⁰ A separate FATCA requirement kicks in on Form 8938 when foreign financial assets exceed $50,000 on the last day of the year or $75,000 at any point during the year for single filers in the U.S., with higher thresholds for joint filers.¹¹ The two filings overlap but are not identical, and penalties for missing either one can dwarf whatever tax you owed on the underlying currency gains.

1
Office of the Law Revision Counsel. 26 USC 988 – Treatment of Certain Foreign Currency Transactions
2
Internal Revenue Service. Frequently Asked Questions on Virtual Currency Transactions
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Tax Foundation. 2026 Tax Brackets
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Internal Revenue Service. Topic No. 409, Capital Gains and Losses
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GovInfo. 26 CFR 1.988-3 – Character of Exchange Gain or Loss
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Office of the Law Revision Counsel. 26 U.S. Code 1256 – Section 1256 Contracts Marked to Market
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Office of the Law Revision Counsel. 26 U.S. Code 988 – Treatment of Certain Foreign Currency Transactions
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Internal Revenue Service. Foreign Currency Transactions – International Practice Unit
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Internal Revenue Service. Foreign Currency and Currency Exchange Rates
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Internal Revenue Service. Report of Foreign Bank and Financial Accounts (FBAR)
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Internal Revenue Service. Do I Need to File Form 8938, Statement of Specified Foreign Financial Assets