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Using a 1256 Contract for a Hedge???

msindc1
Level 4

Folks:

Client (an investor) purchased a vacation home.  He made some futures investments as a hedge on the interest rate fluctuation.  His 1099-B (Section 1256 Transactions) reports $100,000 in profits realized on closed contracts.  The gain/loss worksheet details that $100,000 as the total of the mark-to-market for all the transactions.

I have a few questions:

(1) Can you hedge on a vacation home?  Are there circumstances in which a vacation home can be a trade or business activity?  Does it require renting out the vacation home?

(2) 1256(e) says that mark-to-market does not apply to hedging transactions.  What exactly does that mean?  Does it mean that we do not need to recognize that $100,000 gain?  If so, how do we report that in Lacerte?

Thanks!

Micah

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5 Comments 5
sjrcpa
Level 15

Just like betting, which this sort of is, you can hedge anything.


Ex-AllStar
BobKamman
Level 15

Sounds like he was hedging on interest rates.  For example, he chose a variable-rate mortgage and then bought a futures contract on Treasury notes that would pay off when the Fed did its thing.  So now his mortgage payment has gone up, but he has $100K to make himself feel better.  Can he mark to market?  Should he?  There's a lengthy article here that might help:

https://www.thetaxadviser.com/issues/2010/feb/sec475mark-to-marketelection.html

Depends on whether he is classified as a trader, or an investor.  It might not make any difference, if he closed out the contract (which he probably should have done by now, since the Fed has probably reached its peak).  Does he do any other commodity trading?  

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Terry53029
Level 14
Level 14

I believe since broker reported as mark to market he will have to recognize gain, and they are treated as 60% long term and 40% short term reported on schedule D, regardless of how long the contracts were held. If he has properly and timely identified a section 1256 contract as a hedge then the mark to market rules don't apply, But I am not sure how that works. The few I had the client told me he had not identified them as hedge.

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BobKamman
Level 15

The broker isn't signing the return.  You are.  

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Lylwa
Level 1

Similar to the concept of betting, which can be equated with this situation, you have the option to hedge your position in virtually anything.

 
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