What Is the Significance of the “Constructive Sale” Rule in Section 1256 Taxation?

The constructive sale rule prevents traders from deferring tax on an appreciated position by entering into an offsetting position, such as a short sale or futures contract. If a taxpayer enters into a transaction that substantially eliminates the risk of loss and opportunity for gain, a "constructive sale" is deemed to have occurred.

This triggers a taxable event, forcing the realization of the gain in the current year, thereby preventing tax deferral.