IRS Issues Final Regulations on Integrated Hedging Transactions of Qualifying Debt

By Menna Eltaki, J.D., Chicago, and Douglas Chestnut, CPA, Washington

Editor: Michael Dell, CPA

The IRS published final regulations (T.D. 9736) under Sec. 988(d) addressing certain integrated transactions involving a foreign currency denominated debt instrument and two or more associated hedging transactions. Under the final regulations, a taxpayer that has identified multiple positions as being part of a qualified hedging transaction and terminated at least one but not all of the positions constituting the hedge must treat the remaining hedging positions as having been sold for fair market value (FMV) on the date of the disposition of the terminated hedging position.

The IRS had issued the regulations in temporary and proposed form in September 2012. The temporary regulations were meant to address a perceived abuse of taxpayers claiming a foreign currency loss by partially legging out of an integrated transaction, and they applied to leg-outs that occurred on or after Sept. 6, 2012.

In response to the temporary regulations, the IRS received only one comment, which suggested that the promulgation of the temporary regulations was unnecessary because the perceived abuse at which the temporary regulations were aimed was inconsistent with both the purpose of Sec. 988(d) and the economic substance of the transaction. The comment also recommended that the IRS consider aligning the Sec. 988 hedge integration regime with the Sec. 1275 integration regime. The IRS, however, determined that the temporary regulations are useful in clarifying the Sec. 988(d) integration rule and in preventing unintended approaches to legging-out under those rules and should be adopted as final. The IRS also determined that achieving greater alignment between the hedge integration regimes under Sec. 988 and Sec. 1275 is beyond the scope of the project and unnecessary to achieve the temporary regulations' purpose. The IRS noted that it will, however, continue to consider whether the hedge integration regimes under Secs. 988 and 1275 should be modified and brought into closer conformity.

The final regulations adopt the temporary regulations without substantive change, except for a slight modification in response to a comment on a situation in which an issuer of a qualifying debt legs out but continues to be the obligor. The comment noted that, in that situation, the issuer should be deemed to repurchase and reissue the debt instrument for its then FMV. The final regulations substitute "treated as sold or otherwise terminated by the taxpayer for its fair market value" (emphasis added) for "treated as sold for its fair market value." The final regulations also make some other minor wording changes and update the dates in two existing examples to be consistent with the applicability date of the revised legging-out rules. Following the temporary regulations, the final regulations apply to leg-outs (within the meaning of Regs. Sec. 1.988-5(a)(6)(ii)) that occur on or after Sept. 6, 2012.


The temporary and final regulations are meant to eliminate a small loophole in the legging-out provisions of the integration regulations and should not deter taxpayers' continued use of the integration rules. Additionally, since the final regulations adopt the temporary regulations without any substantive change and maintain the same effective date, the final regulations will likely not significantly affect taxpayers.

The preamble to the final regulations indicates that the IRS may be considering how to better align the integration regimes of Secs. 1275 and 988. An alignment would be useful in preventing inconsistent tax treatment under the two regimes.


Michael Dell is a partner at Ernst & Young LLP in Washington.

For additional information about these items, contact Mr. Dell at 202-327-8788 or

Unless otherwise noted, contributors are members of or associated with Ernst & Young LLP.

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