Futures, Index Options and Prediction Markets: The Year-End Tax Rule That Catches Traders Off Guard

Picture a retiree who bought a stock index futures contract in the spring and watched it climb all year. She plans to hold it into January and assumes the tax can wait until she sells. Federal law says otherwise.

Under 26 U.S.C. § 1256(a)(1), any section 1256 contract still open at the close of the tax year is “treated as sold for its fair market value on the last business day of such taxable year.” Section 1256 contracts include regulated futures contracts and nonequity options. Options on broad stock indexes fall into that second group, and Publication 550 treats only options on a narrow-based stock index as equity options. What the position would sell for that day sets its value. So she owes tax on this year’s gain even though she never closed the trade.

How the Year-End Rule Turns Paper Gains Into Taxable Income

“Marked to market” means evaluating a position at its current price as if you’d sold it. IRS Publication 550, Investment Income and Expenses, spells this out under its “Mark-to-Market Rule”: a section 1256 contract held at year end “will generally be treated as sold at its fair market value on the last business day of the tax year, and you must recognize any gain or loss that results.”

The code avoids taxing the same dollars twice. Section 1256(a)(2) requires a “proper adjustment” to any gain or loss you realize later. The “60/40 rule” example in Publication 550 shows how this works. A trader buys a regulated futures contract for $50,000. On the last business day of the year it’s worth $57,000, so the trader reports a $7,000 gain. In February the trader sells for $56,000 and reports a $1,000 loss measured from the marked value.

Every marked gain or loss gets split the same way, “regardless of how long you actually held the property.”

Seven Traps Hiding in Open Positions

Tax on Money You Haven’t Pocketed

A gain marked at year end can disappear in January. The later loss counts on next year’s return, but the earlier year’s tax bill still stands.

Cash for a Bill on Unclosed Trades

You may owe tax on a position you still hold, so the cash has to come from somewhere else. Values can move fast before the year ends. The CBOE Volatility Index, which is built from S&P 500 index option prices, ran from 14.84 to 19.99 over the past month.

Wash Sale Rule Stays on the Sidelines

Selling a stock and buying a substantially identical one shortly before or after normally prohibits the loss. Under § 1256(f)(5), that rule doesn’t apply to losses taken because of year-end marking. Habits from stock trading don’t carry over directly to futures.

Hedges Count Only if Identified

Publication 550’s “Hedging exception” says “the mark-to-market rule doesn’t apply to hedging transactions.” The catch is in § 1256(e)(2): you must clearly identify the trade as a hedge before the close of the day you enter it. Marking it after the fact doesn’t count.

Mixed Straddles Bring Their Own Election

A straddle is a set of offsetting positions that reduce your risk. A mixed straddle combines section 1256 contracts with other positions, per § 1256(d)(4). You can elect out of marking for those contracts under § 1256(d)(1), but that election applies to later years unless the IRS agrees to a cancellation.

Prediction Markets Sit in a Gray Zone

It’s unclear whether prediction market event contracts are section 1256 contracts at all. Under § 1256(g)(1)(B), a regulated futures contract must trade on or subject to the rules of a qualified board or exchange. Section 1256(g)(7) defines that term three ways: an SEC-registered national securities exchange, a contract market designated by the CFTC, or any other market Treasury determines has adequate rules.

Those decisions come from the IRS one exchange at a time. In Rev. Rul. 2026-16, Section 1256: Section 1256 Contracts Marked to Market, it held that ICE Endex, a regulated Dutch exchange, qualifies under § 1256(g)(7)(C). No IRS notice, revenue ruling, revenue procedure or publication specifically addresses how prediction market event contracts are taxed. Whether year-end marking reaches an open event contract depends on a classification the IRS hasn’t settled.

IRS Is Watching How Section 1256 Treatment Gets Used

In Notice 2026-62, Guidance and Other Actions Being Considered Regarding Certain Potentially Abusive Investment Fund Strategies Involving Financial Products, Treasury and the IRS highlighted “novel investment fund strategies” that may produce unintended tax results. The notice covers investment funds. It does not address prediction markets or individual traders, but it shows regulators are looking closely at how these rules get used.

What to Do Before the Year Closes

1. Review every open position. Know what each one would be worth on the last business day.
2. Keep detailed records. Log entry dates, prices and any hedge designations as you go.
3. Confirm how each contract is classified. Futures, broad index options and event contracts can land in different tax categories.
4. Talk with a tax professional who understands derivatives. This is especially important if you hold straddles or event contracts.

Publication 550 says to use Part I of Form 6781 for gains and losses on all section 1256 contracts that are open at year end or closed during the year, including the amount in box 11 of Form 1099-B. Your broker’s year-end figure already reflects the marking rule, so a contract you never sold can still show up on your return.

Contact [email protected] for any questions or corrections.