Under Section 988 of the Internal Revenue Code, forex trading gains and losses are treated as ordinary income and loss by default, meaning profits are taxed at your marginal rate (up to 37% for 2026) and losses offset other ordinary income with no annual cap. That default is the whole starting point for forex tax rules under Section 988: better than capital treatment when you lose, worse when you win. You can elect out, but the mechanics are narrower than most summaries suggest.
What Section 988 Covers
Section 988 applies to any transaction where the amount you receive or pay is denominated in, or determined by reference to, a nonfunctional currency. For a U.S. taxpayer, that means anything other than the U.S. dollar. Spot forex, forward contracts, currency futures, and options on foreign currencies all fall inside the section’s reach.1Office of the Law Revision Counsel. 26 USC 988 – Treatment of Certain Foreign Currency Transactions
Every dollar of forex gain under Section 988 is ordinary income taxed at your marginal rate. Every dollar of forex loss is an ordinary loss. Rates for 2026 run from 10% to 37% depending on filing status and taxable income.2Internal Revenue Service. Federal Income Tax Rates and Brackets
Why the Default Often Helps Losing Traders
The loss side is where Section 988 actually works in your favor. Ordinary losses offset ordinary income dollar-for-dollar with no annual limit. A $25,000 net forex loss can wipe out $25,000 of salary, freelance income, or other ordinary income on your return.
Compare that to capital losses, which can only offset capital gains plus $3,000 of ordinary income per year, with the rest carried forward.3Internal Revenue Service. Topic No. 409, Capital Gains and Losses Most beginning forex traders lose money, so the default treatment is usually the better deal for them.
The tradeoff shows up in profitable years. A trader in the top bracket pays 37% on forex gains under Section 988 rather than the long-term capital gains rate that other investments enjoy. Better loss treatment now, higher tax on profits later.
Electing Out of Section 988
Section 988(a)(1)(B) permits a taxpayer to elect capital gains treatment for certain forex contracts. Treasury Regulation 1.988-3(b) governs the election and allows it for forward contracts, futures contracts, and options on foreign currencies, provided the contract is a capital asset and is not part of a straddle.4eCFR. 26 CFR 1.988-3 – Character of Exchange Gain or Loss
Here is what most summaries get wrong. Electing out of Section 988 does not automatically give you the 60/40 split under Section 1256. It gives you standard capital gains treatment. If you hold a position for a year or less, which describes nearly all retail spot forex, gains are short-term capital gains taxed at the same rate as ordinary income. You gain nothing on the rate side and lose the unlimited loss deduction. The election primarily helps traders who hold positions longer than a year or who have large capital gains from other investments that forex losses can offset.
Section 1256 and the 60/40 Split
Section 1256 provides the genuinely favorable rate structure people associate with forex trading: 60% of gains taxed at long-term capital gains rates (0%, 15%, or 20%) and 40% at short-term rates, regardless of holding period.5Office of the Law Revision Counsel. 26 USC 1256 – Section 1256 Contracts Marked to Market For a top-bracket trader, the blended rate on profits works out to roughly 26% instead of 37%.
Section 1256 applies only to contracts meeting its definition. For forex, that means “foreign currency contracts” traded in the interbank market and priced by reference to interbank rates. Regulated futures contracts on foreign currencies (EUR/USD futures on the CME, for example) also qualify.
The tradeoff is the loss side. Net capital losses under Section 1256 are subject to the standard capital loss limitation: they offset capital gains and up to $3,000 of ordinary income per year. Section 1256 does add one benefit unavailable elsewhere: individual taxpayers can carry back net Section 1256 losses to the three preceding tax years and apply them against Section 1256 gains reported in those years.6Internal Revenue Service. Form 6781 – Gains and Losses From Section 1256 Contracts and Straddles
Regulated Futures Default to Section 1256
Currency futures and nonequity options that qualify as Section 1256 contracts are automatically pulled out of Section 988 and into Section 1256. If you trade EUR/USD futures on a regulated exchange, you get the 60/40 split by default without making any election. You can elect back into Section 988 ordinary treatment if you prefer the unlimited loss deduction, but that election must be made on or before the first day of the tax year, or the first day you hold such a contract.
Retail Spot Forex Sits in a Gray Area
Most retail forex trading happens through over-the-counter brokers rather than the interbank market. Whether these contracts qualify as “foreign currency contracts” under Section 1256(g)(2) is unsettled. The statute requires interbank trading and interbank pricing, and a retail account at an online broker does not obviously meet those criteria. Some practitioners argue the contracts functionally satisfy the definition because retail brokers hedge in the interbank market and derive their pricing from interbank rates. Others take the conservative position that retail spot forex stays in Section 988 and the only election available is the capital gains election under Regulation 1.988-3(b), which produces standard capital gains treatment without the 60/40 split.
If you claim 60/40 treatment on retail spot forex and the IRS disagrees, returns can be reclassified back to ordinary treatment with penalties and interest. The safest path for retail spot traders is to stay with the Section 988 default, or if electing out, to treat gains as standard capital gains and consult a tax professional before claiming Section 1256’s 60/40 split.
How to Document the Election
The Section 988 opt-out election is not filed with the IRS. It lives in your own books and records. Treasury Regulation 1.988-3(b)(3) requires you to “clearly identify” each transaction subject to the election on the date the transaction is entered into. The regulation prescribes no specific language, but the identification method must be consistent and must clearly show which transactions the election covers.
Most traders create a signed, dated declaration before they begin trading for the year. A typical statement reads: “I elect under Section 988(a)(1)(B) to treat gains and losses on my foreign currency transactions as capital gains and losses.” Include the date, your name, and the brokerage accounts covered.
Timing is the critical requirement. You cannot apply the election retroactively to trades that already occurred. If you sign the election on March 15, it covers trades from March 15 forward, not January’s trades. Store the document with your permanent tax records; you only need to produce it if the IRS audits your return and questions why forex income was reported as capital rather than ordinary. The IRS Commissioner has discretion to invalidate elections that don’t comply with the regulation, so consistency and clear documentation matter.
Revoking the election is not straightforward. Once you elect out of Section 988 for certain contract types, proposed Treasury regulations require the IRS Commissioner’s consent to revoke. Treat the election as a one-way door unless you’re prepared to go through a formal approval process.
Reporting Forex Income on Your Return
The forms you use depend on which treatment applies.
Section 988 Ordinary Treatment
Net forex gains or losses under Section 988 are reported on Form 1040, Schedule 1, on the “Other Income” line. The amount flows into your adjusted gross income calculation on the main Form 1040. No additional schedules are required, and you enter a single net figure rather than listing every trade.
Section 1256 Treatment
Contracts qualifying for Section 1256 go on Form 6781, Gains and Losses From Section 1256 Contracts and Straddles.7Internal Revenue Service. About Form 6781, Gains and Losses From Section 1256 Contracts and Straddles The form splits your net result: 40% goes to the short-term line and 60% to the long-term line, and those figures carry over to Schedule D. To carry back a net Section 1256 loss, check box D on Form 6781 and file Form 1045 or an amended return for the carryback year, attaching amended Forms 6781 and Schedule D for each affected year.
Capital Gains Election Without Section 1256
If you elected out of Section 988 but your contracts don’t qualify for Section 1256, report gains and losses on Schedule D and Form 8949 like any other capital asset. Short-term and long-term classification depends on your actual holding period.
When Your Broker Doesn’t Send a 1099
Most retail forex brokers do not issue Form 1099-B for spot currency trades. Unlike stock brokers, they generally are not required to report cost basis to the IRS for these transactions. That doesn’t reduce your reporting obligation. It shifts the recordkeeping burden onto you.
Download your trade history from your broker’s platform for the full tax year. You need date opened, date closed, currency pair, position size, entry price, exit price, and any rollover credits or debits for every position. Most platforms export the data as a spreadsheet. Keep these records for at least three years after filing, longer if you carry losses forward or back. If the IRS questions your return, the broker’s trade log is your primary evidence.
Rollover Interest and Swap Charges
When you hold a forex position overnight, your broker credits or debits rollover interest (sometimes called a swap) based on the interest rate differential between the two currencies. Section 988 treats these amounts as ordinary income or loss along with the overall transaction. The statute also allows regulations to recharacterize such amounts as interest income or interest expense. Either way they are taxable, and you should track them separately from your trading gains and losses.
The 3.8% Net Investment Income Tax
Forex profits can trigger the Net Investment Income Tax, a 3.8% surtax on investment income for taxpayers whose modified adjusted gross income exceeds $200,000 (single), $250,000 (married filing jointly), or $125,000 (married filing separately).8Internal Revenue Service. Topic No. 559, Net Investment Income Tax These thresholds are not adjusted for inflation.
The IRS defines net investment income to include income from trading financial instruments and commodities, which covers forex.9Internal Revenue Service. Questions and Answers on the Net Investment Income Tax The surtax applies whether your forex income is ordinary under Section 988 or capital under an opt-out election. For a high-income trader, the effective top rate on forex gains under Section 988 reaches 40.8%.
Wash Sale Rules and Forex
The wash sale rule under Section 1091 disallows a loss deduction when you sell a security at a loss and buy a substantially identical security within 30 days before or after. The rule applies specifically to “stock or securities,” and foreign currencies do not fit neatly into either category.
For traders under Section 988’s default ordinary treatment, the statute does not reference the wash sale rule, and ordinary forex losses are generally not subject to it. For Section 1256 contracts, the statute explicitly exempts mark-to-market losses from the wash sale rule. The gray area is traders who elected out of Section 988 into standard capital gains treatment without Section 1256 protection. The IRS has not issued definitive guidance on whether forex positions in that category are “securities” subject to wash sale rules, so conservative traders should be aware of the risk.
Foreign Account Reporting for Offshore Brokers
Trading forex through a broker based outside the United States triggers separate reporting obligations that have nothing to do with how gains are taxed.
FBAR (FinCEN Form 114)
If the combined value of your foreign financial accounts, including brokerage accounts, exceeds $10,000 at any point during the year, you must file a Report of Foreign Bank and Financial Accounts.10Internal Revenue Service. Report of Foreign Bank and Financial Accounts (FBAR) The report goes to FinCEN’s BSA E-Filing system, not to the IRS with your return. The deadline is April 15, with an automatic extension to October 15. Whether the account produced taxable income is irrelevant; the $10,000 threshold is the trigger.
Penalties are severe. Non-willful violations carry civil penalties that exceed $16,000 per account per year, adjusted for inflation annually. Willful violations can reach the greater of roughly $165,000 or 50% of the account balance, per account per year, and intentional non-compliance can bring criminal penalties.
FATCA (Form 8938)
The Foreign Account Tax Compliance Act imposes a separate reporting requirement on Form 8938 for taxpayers with specified foreign financial assets above certain thresholds. For single filers living in the U.S., the threshold is $50,000 on the last day of the tax year or $75,000 at any point during the year. For married couples filing jointly, the thresholds double to $100,000 and $150,000.11Internal Revenue Service. Do I Need to File Form 8938, Statement of Specified Foreign Financial Assets? Taxpayers living abroad have significantly higher thresholds. Form 8938 attaches to your tax return, unlike the FBAR. The two forms have overlapping coverage but different thresholds and filing procedures, so a foreign forex account can trigger both at once.
Cryptocurrency Is Not Foreign Currency
The IRS treats virtual currency as property, not as a foreign currency. Its guidance defines virtual currency as a digital representation of value “other than a representation of the U.S. dollar or a foreign currency.”12Internal Revenue Service. Frequently Asked Questions on Virtual Currency Transactions Section 988 does not apply to cryptocurrency transactions. When you sell Bitcoin for dollars, you recognize a capital gain or loss under the general property rules. The unlimited loss deduction, the 60/40 election, and the other forex-specific rules covered here do not reach crypto trades.