Forex trading can be volatile. Some years are profitable, others come with losses.
If you’re wondering whether you can deduct those losses on your taxes, the answer depends on your trading status and how your activity is classified.
Trader vs. Investor: Know the Difference
The IRS doesn’t view all forex traders the same. If you’re trading casually or sporadically, you’re considered an investor.
But if you’re actively trading with the intent to profit from short-term price movements, and you do so regularly and consistently, you may qualify as a trader in securities.
That distinction matters, because the tax treatment for traders versus investors is very different, especially when it comes to reporting and deductions.
Forex Falls Under Section 988 by Default
By default, most forex trades fall under Section 988 of the tax code.
This section treats gains and losses as ordinary income or loss. The upside to Section 988 is that it doesn’t limit your losses to $3,000 per year like capital losses under.
Section 1211. If you lose $10,000 trading forex under Section 988, you can deduct the full $10,000 in the same year against your other income.
That flexibility can be a tax-saver for traders who had a rough year in the markets.
Electing Section 1256 Treatment
Some types of forex contracts may be eligible for Section 1256 treatment, which allows for a more favorable blended tax rate which is 60% for long-term capital gains and 40% for short-term.
This treatment is usually more relevant to traders dealing in futures or broad-based currency contracts. However, to use Section 1256, you must make a special election in advance.
It’s not available by default, and many traders either miss the deadline or aren’t aware they have to elect it at all. I’ve seen traders unintentionally default into less favorable tax positions just from a lack of planning.
How to Deduct Your Losses
If you’re under Section 988, your losses are treated as ordinary losses and are generally reported on Form 4797 or, in some business-use cases, on Schedule C.
If you made the Section 1256 election, your losses become capital losses and are reported on Form 6781.
Just remember that capital losses are limited to $3,000 per year against ordinary income unless you have capital gains to offset them.
If you’re trading through a formal business entity like an LLC or S-Corp, the method of reporting may differ and could give you more flexibility in how the losses are applied.
Important Considerations
You must maintain strong supporting documentation which means detailed trade logs, profit and loss reports, and records of any elections made with the IRS. I can’t stress this enough.
Having the correct documents on hand can be the difference between a smooth filing and a disallowed deduction.
Glossary of Key Tax Forms & Terms
Form 4797 – Used to report the sale of business property and ordinary gains and losses, including Section 988 losses for active traders.
Schedule C – Used by sole proprietors and single-member LLCs to report self-employment income and business- related expenses.
Form 6781 – Used to report gains and losses under Section 1256 contracts, including futures and certain forex trades if elected.
Section 988 – Governs the taxation of foreign currency transactions. Gains and losses are treated as ordinary income or loss, with no capital loss limitation.
Section 1256 – Allows for a 60% long-term and 40% short-term capital gains tax treatment on certain contracts, provided a timely election is made.
Section 1211 – Limits the deduction of capital losses for individuals to the amount of capital gains plus up to $3,000 of ordinary income per year.
Capital Loss Limitation – A rule under Section 1211 that restricts the annual use of capital losses to offset ordinary income beyond $3,000, unless there are capital gains.
LLC / S-Corp – Types of business entities that may offer different tax reporting and planning advantages for active traders depending on their scale and goals.
Final Thoughts
Yes, forex trading losses can be deductible, but how much and how you report them depends on your trading status and the tax elections you’ve made.
Understanding Section 988 versus 1256 is key to navigating this correctly. If you don’t get it right, you could be leaving money on the table.
I help traders like you make sense of these rules every tax season. Getting the structure and reporting strategy right up front leads to much better outcomes.
Dat Ngo is a licensed CPA with a background in corporate and freelance accounting, specializing in tax strategy, financial analysis, and business consulting. With experience serving individuals, startups, and small businesses, he brings a practical, client-focused approach to financial clarity and compliance.