Before you enter your foreign currency transactions, you must determine whether the gain or (loss) is subject to IRC (Internal Revenue Code) 1256 or 988. If you are unsure how to classify your trades, it is best to seek professional tax advice from your broker or a qualified tax professional (Enrolled Agent, CPA, or attorney).
By default, Cash Forex is subject to IRC 988 rules with ordinary gain or (loss) treatment. However, if you are a trader, you can elect out of IRC 988. This will allow your gains to be treated as IRC 1256 with beneficial 60/40 capital gain treatment. The election out of IRC 988 is an internal election. This means you should document the election in your own records before you make the trades.
IRC 988
If you did NOT elect out of IRC 988, the gain or (loss) would be subject to IRC 988. You would enter the information on Schedule 1 (Form 1040) as an ordinary gain or (loss). To enter a description and an amount for Schedule 1 (Form 1040), use the steps listed in the Form 1040 - Other Income FAQ. Optional - check the box Election under section 988 that is available while entering Form 6781 - Section 1256 Contracts and Straddles - Futures Contracts elections.
IRC 1256
If you DID elect out of IRC 988, the gain or (loss) would be subject to IRC 1256. You would enter the information on Form 6781, Gains and Losses From Section 1256 Contracts and Straddles, Part I, and it would be subject to the 60/40 capital gains treatment. See the Form 6781 - Section 1256 Contracts and Straddles - Futures Contracts FAQ for details. Based on the information entered, the appropriate calculations will be done on Form 6781 so that 40% of the gain or loss is reported as short-term on Line 8 and 60% of the gain or loss is reported as long-term on Line 9 of the form. These amounts are then transferred to the appropriate line(s) on Schedule D (Form 1040), Capital Gains and Losses.
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