IRS Announces Section 1256 Tax Breaks for the Managed Futures Industry

You don't often hear the phrase "you can never have too much of a good thing" when talking about tax-related announcements. However, recent revenue rulings from the IRS provide a positive outcome to the managed futures industry - and particularly to Commodity Trading Advisors (CTAs) and Commodity Pool Operators (CPOs).

Revenue Ruling 2024-22 and Revenue Ruling 2024-23 are important to the managed futures industry because investors in funds that trade commodity futures contracts and non-equity options are granted beneficial long-term tax treatment on 60 percent of their trading gains. Furthermore, the commodity exchanges impacted by these announcements may likely benefit from incentivized participation within their markets, which could also lead to greater liquidity for managed future traders.

Both CTAs and CPOs should understand the markets impacted by these announcements and consider taking advantage of the new rules.

Revenue Ruling 2024-22 and Revenue Ruling 2024-23

The last time the IRS announced that a foreign futures exchange was a qualified board or exchange and eligible for favorable tax treatment was in 2013 with the Eurex Deutschland exchange. However, within the span of two weeks, the IRS has issued Revenue Ruling 2024-22 impacting the Bourse de Montreal (MX), and Revenue Ruling 2024-23 impacting the European Energy Exchange (EEE).

With both rulings, each exchange officially becomes a qualified board of exchange within the meaning of Internal Revenue Code (IRC) Section 1256(g)(7)(C). A qualified board or exchange is defined as being in one of three broad groups:

1. A national securities exchange registered with the SEC;
2. A domestic board of trade designated as a contract market by the Commodity Futures Trading Commission (CFTC); or
3. Any other exchange, board of trade or other market Treasury determines has rules adequate to carry out mark-to-market reporting.

Accordingly, most domestic commodity exchanges meet the first part of this definition; and, since they are required to be registered with the CFTC, most will also meet the second part of the definition. Therefore, almost all futures contracts and non-equity options contracts traded on a domestic board of trade will meet this definition.

A number of foreign exchanges have been designated by the secretary of the Treasury, including ICE Futures UK, Dubai Mercantile Exchange, ICE Futures Canada, London International Financial Futures and Options Exchange (LIFFE), and Eurex Deutschland. Now the MX and EEE exchanges will join this list.

Section 1256 Benefit

Sec. 1256 requires all positions in regulated futures contracts and certain non-equity options that are traded on a qualified board or exchange qualify to be treated as if they were sold for fair market value on the last day of the tax year under the mark-to-market tax provisions.

Further, Sec. 1256 allows the gains or losses from all positions held at year-end to be treated as 60 percent long-term capital gain or loss and 40 percent short-term capital gain or loss, without regard to the actual holding period. This is commonly referred to as the 60/40 split of gain or losses.

Absent Sec. 1256 tax treatment, most foreign traded futures contracts and non-equity options would be either taxable as a capital asset, if the futures contract represents an index or commodity positions, or as an ordinary taxable asset, if the futures contract represents a foreign bond or bill. In both instances, the tax rate would be higher than under the 60/40 split tax rate and less beneficial for investors.

Why These Exchanges?

With the Bourse de Montreal (MX), it previously was associated with the Mercantile Division of the Montreal Exchange, which had previously been granted IRC Section 1256 (g)(7)(C) tax treatment under Revenue Ruling 86-7, which now becomes obsolete. The CFTC had in fact granted MX an Order of Registration on August 15, 2015, to allow direct access to electronic trading and order matching systems from within the U.S. This is a key requirement to being granted the beneficial tax treatment.

In the instance of the European Energy Exchange (EEE), the CFTC had granted a similar Order of Registration, allowing direct access to electronic trading and order matching within the U.S. on November 5, 2019.

Effective Dates

The revenue rulings are effective for MX and EEE contracts entered into on or after November 1, 2024. In both instances, the IRS has granted a change in method of accounting on a cut-off basis to the mark-to-market method of accounting for these contracts for the first taxable year in which the taxpayer holds these contracts.

These revenue rulings are important to the industry and provide a double tax benefit to managed future participants. Whether you are a seasoned CTA or CPO, or an emerging manager in this space, talk with an experienced tax adviser about how these rulings impact your fund's trading strategies.

Contact Peter Gilroy-Scott or a member of your service team to discuss this topic further.

Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law with your professional advisers.

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