The values of currencies are constantly changing and investors can speculate upon and profit from trading foreign currencies through FOREX accounts. Because there are different types of FOREX trading, there are different ways for investors to claim gains or losses on their taxes. Each way offers advantages and disadvantages, depending upon whether the FOREX account makes a profit or not. However, the investors must decide how they will file their taxes before making the trades and overconfident investors could be caught paying later.
Investors use FOREX accounts to buy and sell foreign currencies, including the U.S., Australian and Canadian dollars, the euro, the British pound and the Japanese yen. The FOREX market is the largest financial market in the world and it offers many advantages to investors, including favorable taxes. FOREX accounts can be started for as little as $250, according to Forbes, and investors can “leverage” their position by borrowing from brokers, making successful trades even more profitable. The market’s size makes for quick buying and selling of the currency, making it easy for investors to get out of their positions at or near the price they’ve targeted. Another FOREX advantage is that it can be traded overnight, since countries in different time zones operate when U.S. markets are closed.
Types of Trades
All foreign currency trades are made in one of two ways, according to American Express. In an over-the-counter trade, or “spot trade,” an investor buys a short-term contract that closes in a few days. The other type of trade is a commodity futures contract, where the investor can set a longer-time contract that can be months in the future. Many FOREX accounts allow for both kinds of trades and investors may need to keep close track of which types of trades account for their profits and losses.
Over-the-Counter FOREX Taxes
The Internal Revenue Service automatically covers over-the-counter FOREX trading under Section 988, which treats FOREX gains as short-term ordinary income, requiring investors to pay standard income-tax rates on these profits. While this tax treatment doesn’t let investors get the lower capital-gains rate, it is a better option if they record losses from their FOREX trading, though this may be a small consolation. FOREX is a risky investment than can defy expectations and produce unexpected losses for traders, writes the Wall Street Journal.
Taxes on FOREX Futures
IRS Section 1256 covers taxes on FOREX future contracts. With this option, investors can get the better capital-gains tax rate for 60 percent of the FOREX profits, with the other 40 percent treated as ordinary income. For the highest income-tax bracket of 39.6 percent, Section 1256 offers a tax rate of 28 percent on FOREX-account profits. However, this tax treatment also limits the amount of losses that a taxpayer can deduct. If the investor suffers unexpected losses in their FOREX account, they might have to wait until next year to deduct the losses, leaving them with a higher bill this year. In order to qualify for Section 1256 tax treatment, the investor must claim this treatment before making any trades.
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