[Federal Register Volume 60, Number 245 (Thursday, December 21, 1995)]
[Rules and Regulations]
[Pages 66083-66085]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-30900]
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DEPARTMENT OF THE TREASURY
26 CFR Parts 1 and 602
[TD 8649]
RIN 1545-AS87
Regulations Under Section 1258 of the Internal Revenue Code of
1986; Netting Rule for Certain Conversion Transactions
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations relating to
conversion transactions. These regulations provide that certain gains
and losses from positions of the same conversion transaction may be
netted for purposes of determining the amount of gain that is
recharacterized as ordinary income. These regulations reflect changes
to the law made by the Revenue Reconciliation Act of 1993 and affect
persons who enter into conversion transactions.
DATES: These regulations are effective December 21, 1995.
For applicability of these regulations, see EFFECTIVE DATES under
the SUPPLEMENTARY INFORMATION part of the preamble.
FOR FURTHER INFORMATION CONTACT: Alan B. Munro, (202) 622-3950 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in these final regulations
has been reviewed and approved by the Office of Management and Budget
in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under
control number 1545-1452. Responses to this collection of information
are required to obtain netting relief for conversion transactions.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number.
The estimated annual burden per recordkeeper varies from .05 to 10
hours, depending on individual circumstances, with an estimated average
of .10 hour.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington,
DC 20224, and to the Office of Management and Budget, Attn: Desk
Officer for the Department of the Treasury, Office of Information and
Regulatory Affairs, Washington, DC 20503.
Books or records relating to this collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
On December 27, 1994, the IRS published in the Federal Register a
notice of proposed rulemaking and notice of public hearing at 59 FR
66498 (FI-43-94) under section 1258 of the Internal Revenue Code of
1986.
The IRS received a number of written comments on the proposed
regulations. No requests to speak at the public hearing were received,
however, and consequently the hearing was cancelled.
Explanation of Provisions
A. General
The proposed regulations allow taxpayers to net gains and losses on
the positions of certain conversion transactions for purposes of
section 1258(a). For a taxpayer to be eligible, the proposed
regulations require the taxpayer to identify, before the close of the
day on which the positions become part of the conversion transaction,
all the positions that are part of the conversion transaction. In
addition, the taxpayer has to dispose of all the positions within a 14-
day period that is within a single taxable year. The proposed
regulations also define built- in loss and prohibit the netting of
built-in loss against gain.
The commenters uniformly supported the netting relief provided by
the proposed regulations. Accordingly, the final regulations are
substantially unchanged from the proposed regulations.
The proposed regulations provide that the regulations will be
effective for conversion transactions entered into on or after the date
of filing of final regulations with the Federal Register. Several
commenters requested that the regulations also apply to conversion
transactions entered into prior to the filing date. In response to
these comments, the final regulations provide for application of the
regulations to any conversion transaction that is outstanding on
December 21, 1995, provided that all the positions which are part of
the conversion transaction are identified under Sec. 1.1258-1(b)(2)
before the close of business on February 20, 1996. The final
regulations also provide a transition rule for the same-day
identification requirement that allows taxpayers to identify conversion
transactions entered into prior to February 20, 1996, at any time on or
before February 20, 1996.
Several commenters criticized the examples for failing to adjust
the applicable imputed income amount (AIIA) under section 1258(b) for
interest and dividends received. The scope of these regulations,
however, is limited to netting relief. The IRS is still studying
various situations to determine the extent to which it is appropriate
to reduce the AIIA by reason of amounts capitalized under section
263(g), ordinary income received, or otherwise. Accordingly, Example 3
has been deleted and Examples 1 and 2 have been clarified to eliminate
any implication on this issue.
One commenter requested that the identification requirement be
eliminated as impractical, unnecessary, and a trap for the unwary. This
same-day identification requirement is similar to identification
requirements under sections 475 and 1221. Identification of all the
positions of a conversion transaction will aid examiners attempting to
determine whether conversion transactions are present and will prevent
mismatching of those positions by both taxpayers and agents. The final
regulations retain the same-day identification requirement but provide
a transition rule.
[[Page 66084]]
Some commenters asked that netting relief be expanded to cover
unrealized losses in retained positions by allowing loss positions to
be marked to market when a gain position is disposed of or terminated.
Allowing retained positions to be marked to market raises valuation and
other potentially complex issues. For example, many of the issues
addressed by the regulations under section 475 would have to be
addressed here. The complexity of these issues outweighs the potential
benefit of allowing retained positions to be marked to market. Thus,
the final regulations do not include a mark-to-market provision.
To preserve the character of gain that arose before a position
became part of a conversion transaction, one commenter requested built-
in gain rules similar to the built-in loss rules in the proposed
regulations. The appropriateness of a built-in gain rule under section
1258 is beyond the scope of these regulations. Therefore, the final
regulations do not address this issue.
The IRS is aware that section 1258 presents a number of issues not
addressed by these final regulations. The IRS continues to study the
scope of section 1258, the types of transactions that should be
included under the regulatory authority of section 1258(c)(2)(D), and
what reductions, if any, in the AIIA are appropriate under section
1258(b). The IRS welcomes comments on these and other issues under
section 1258.
B. Effective Dates
The regulations are effective for conversion transactions that are
outstanding on or after December 21, 1995. In the case of a conversion
transaction entered into before February 20, 1996, the same-day
identification requirement is treated as satisfied if the
identification is made on or before February 20, 1996.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to
these regulations, and, therefore, a Regulatory Flexibility Analysis is
not required. Pursuant to section 7805(f) of the Internal Revenue Code,
the notice of proposed rulemaking preceding these regulations was
submitted to the Small Business Administration for comment on its
impact on small business.
Drafting Information: The principal author of these regulations
is Alan B. Munro, Office of Assistant Chief Counsel (Financial
Institutions and Products). However, other personnel from the IRS
and Treasury Department participated in their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 602 are amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.1258-1 is added to read as follows:
Sec. 1.1258-1 Netting rule for certain conversion transactions.
(a) Purpose. The purpose of this section is to provide taxpayers
with a method to net certain gains and losses from positions of the
same conversion transaction before determining the amount of gain
treated as ordinary income under section 1258(a).
(b) Netting of gain and loss for identified transactions--(1) In
general. If a taxpayer disposes of or terminates all the positions of
an identified netting transaction (as defined in paragraph (b)(2) of
this section) within a 14-day period in a single taxable year, all
gains and losses on those positions taken into account for federal tax
purposes within that period (other than built-in losses as defined in
paragraph (c) of this section) are netted solely for purposes of
determining the amount of gain treated as ordinary income under section
1258(a). For purposes of the preceding sentence, a taxpayer is treated
as disposing of any position that is treated as sold under any
provision of the Code or regulations thereunder (for example, under
section 1256(a)(1)).
(2) Identified netting transaction. For purposes of this section,
an identified netting transaction is a conversion transaction (as
defined in section 1258(c)) that the taxpayer identifies as an
identified netting transaction on its books and records. Identification
of each position of the conversion transaction must be made before the
close of the day on which the position becomes part of the conversion
transaction. No particular form of identification is necessary, but all
the positions of a single conversion transaction must be identified as
part of the same transaction and must be distinguished from all other
positions.
(c) Definition of built-in loss. For purposes of this section,
built-in loss means--
(1) Built-in loss as defined in section 1258(d)(3)(B); and
(2) If a taxpayer realizes gain or loss on any one position of a
conversion transaction (for example, under section 1256), as of the
date that gain or loss is realized, any unrecognized loss in any other
position of the conversion transaction that is not disposed of,
terminated, or treated as sold under any provision of the Code or
regulations thereunder within 14 days of and within the same taxable
year as the realization event.
(d) Examples. These examples illustrate this section:
Example 1. Identified netting transaction with simultaneous
actual dispositions. (i) On December 1, 1995, A purchases 1,000
shares of XYZ stock for $100,000 and enters into a forward contract
to sell 1,000 shares of XYZ stock on November 30, 1997, for
$110,000. The XYZ stock is actively traded as defined in
Sec. 1.1092(d)-1(a) and is a capital asset in A's hands. A maintains
books and records on which, on December 1, 1995, it identifies the
two positions as all the positions of a single conversion
transaction. A owns no other XYZ stock. On December 1, 1996, when
the applicable imputed income amount for the transaction is $7,000,
A sells the 1,000 shares of XYZ stock for $95,000. On the same day,
A terminates its forward contract with its counterparty, receiving
$10,200. No dividends were received on the stock during the time it
was part of the conversion transaction.
(ii) The XYZ stock and forward contract are positions of a
conversion transaction. Under section 1258(c)(1), substantially all
of A's expected return from the overall transaction is attributable
to the time value of the net investment in the transaction. Under
section 1258(c)(2)(B), the transaction is an applicable straddle as
defined in section 1258(d)(1).
(iii) A disposed of or terminated all the positions of the
conversion transaction within 14 days and within the same taxable
year as required by paragraph (b)(1) of this section. The
transaction is an identified netting transaction because it meets
the identification requirement of paragraph (b)(2) of this section.
Solely for purposes of section 1258(a), the $5,000 loss realized
($100,000 basis less $95,000 amount realized) on the disposition of
the XYZ stock is netted against the $10,200 gain recognized on the
disposition of the forward contract. Thus, the net gain from the
conversion transaction for purposes of section 1258(a) is $5,200
[[Page 66085]]
($10,200 gain less $5,000 loss). Only the $5,200 net gain is
recharacterized as ordinary income under section 1258(a) even though
the applicable imputed income amount is $7,000. For federal tax
purposes other than section 1258(a), A has recognized a $10,200 gain
on the disposition of the forward contract ($5,200 of which is
treated as ordinary income) and realized a separate $5,000 loss on
the sale of the XYZ stock.
Example 2. Identified netting transaction with built-in loss.
(i) The facts are the same as in Example 1, except that A had
purchased the XYZ stock for $104,000 on May 15, 1995. The XYZ stock
had a fair market value of $100,000 on December 1, 1995, the date it
became part of a conversion transaction.
(ii) The results are the same as in Example 1, except that A has
built-in loss (in addition to the $5,000 loss that arose
economically during the period of the conversion transaction), as
defined in section 1258(d)(3)(B), of $4,000 on the XYZ stock. That
$4,000 built-in loss is not netted against the $10,200 gain on the
forward contract for purposes of section 1258(a). Thus, the net gain
from the conversion transaction for purposes of section 1258(a) is
$5,200, the same as in Example 1. The $4,000 built-in loss is
recognized and has a character determined without regard to section
1258.
(e) Effective date and transition rule--(1) In general. These
regulations are effective for conversion transactions that are
outstanding on or after December 21, 1995.
(2) Transition rule for identification requirements. In the case of
a conversion transaction entered into before February 20, 1996,
paragraph (b)(2) of this section is treated as satisfied if the
identification is made before the close of business on February 20,
1996.
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
Par. 3. The authority citation for part 602 continues to read as
follows:
Authority: 26 U.S.C. 7805.
Sec. 602.101 [Amended]
Par. 4. In Sec. 602.101, paragraph (c) is amended by adding the
entry ``1.1258-1 * * * .1545-1452'' in numerical order to the table.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved: November 28, 1995.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 95-30900 Filed 12-20-95; 8:45 am]
BILLING CODE 4830-01-U