Current Developments for Straddle Transactions

By Jeff Borghino, CPA, Washington, D.C.

Editor: Greg A. Fairbanks, J.D., LL.M.

Gains & Losses

Sec. 1092, the Sec. 1092 regulations, and Sec. 263(g) (the straddle rules) govern the taxation of straddle transactions. The straddle rules were enacted in 1981 to prevent the deferral of income and the conversion of ordinary income and short-term capital gain into long-term capital gain (Staff of the Joint Committee on Taxation, General Explanation of the Economic Recovery Tax Act of 1981 (JCS-71-81) at 283 (Dec. 29, 1981) (the 1981 Blue Book)).

While a comprehensive discussion of the straddle rules is not within the scope of this item, the straddle rules include (1) the wash-sale rule under Temp. Regs. Sec. 1.1092(b)-1T(a)(1), which is similar to the wash-sale rule of Sec. 1091 that applies to dispositions of part of a straddle; (2) the loss-deferral rule under Sec. 1092(a) and Temp. Regs. Sec. 1.1092(b)-1T(a)(2), which disallows losses related to dispositions of part of a straddle to the extent of certain unrecognized gains; (3) the holding-period rule under Temp. Regs. Sec. 1.1092(b)-2T, which suspends the holding period of a position while it is part of a straddle; and (4) Sec. 263(g), which disallows certain interest and carrying charges related to a straddle.

Recently the IRS issued regulations clarifying (1) whether an obligor’s debt could be part of a straddle (the debt-straddle regulation) and (2) the treatment of prestraddle gain or loss related to a position that is part of a “mixed straddle” as defined in Temp. Regs. Sec. 1.1092-5T(e) (the premixed straddle regulation). This item provides a brief background and summary of these regulations.

Background of the Debt-Straddle Regulation

Sec. 263(g)(1) disallows a deduction for interest and carrying charges that are properly allocable to personal property that is part of a straddle.

Sec. 263(g)(2) defines “interest and carrying charges” to mean the excess of (1) the interest related to debt that is “incurred or continued to purchase or carry the personal property” and all other amounts paid or incurred to carry the personal property over (2) certain receipts with respect to the personal property.

Sec. 263(g) does not apply to a hedging transaction as defined in Sec. 1256(e) (Sec. 263(g)(3)).

A “straddle” is defined in Sec. 1092(c)(1) as “offsetting positions with respect to personal property.” Positions are considered offsetting if there is a substantial diminution of the taxpayer’s risk of loss from holding one position by reason of holding the other position (Sec. 1092(c)(2)(A)). Sec. 1092(d)(1) defines “personal property” as any personal property that is actively traded. Stock is included as personal property only if (1) the stock is actively traded and at least one of the positions offsetting the stock is a position with respect to the stock or substantially similar or related property; or (2) the stock is of a corporation formed or availed of to take positions in personal property that offset positions taken by any shareholder (Sec. 1092(d)(3)).

A “position” is defined in Sec. 1092(d)(2) as an interest in personal property including a futures contract, a forward contract, or an option.

From the holder’s perspective, a debt may constitute personal property if it is actively traded (the 1981 Blue Book at 289). From the obligor’s perspective, a debt is generally not regarded as personal property; however, a debt may represent a position in personal property under certain circumstances. For example, Sec. 1092(d)(7) provides that an obligor’s interest in a nonfunctional-currency-denominated debt obligation is treated as a position in a nonfunctional currency. In addition, Regs. Sec. 1.1275-4(b)(9)(vi) contemplates that a contingent payment debt instrument may be a position in a straddle such that the issuer will treat a positive adjustment as a loss with respect to such straddle.

Despite Regs. Sec. 1.1275-4(b)(9)(vi), some taxpayers had taken the position that debt could be a position in a straddle only to the extent specifically provided under Sec. 1092(d)(7) (i.e., an issuer’s debt was not a position in personal property if it was not denominated in a nonfunctional currency). For example, the taxpayer in Taxpayer Advice Memorandum (TAM) 200541040 (10/14/05) took a position that its debt, which was exchangeable into publicly traded stock the taxpayer owned, was not part of a straddle. The taxpayer asserted that Congress would not have written Sec. 1092(d)(7) so narrowly if it intended for a debt obligation to be treated as a position in personal property of the issuer under other circumstances.

The IRS clarified its position in 2001 by issuing Prop. Regs. Sec. 1.1092(d)-1(d), which provided that an obligor’s debt instrument is a position with respect to personal property and may be part of a straddle if one or more payments are linked to the value of personal property or a position with respect to personal property.

The proposed regulations were to be effective for straddles established on or after Jan. 17, 2001, upon being adopted as final regulations.

The IRS stated the following in the preamble to Prop. Regs. Sec. 1.1092-1(d):

To clarify the definition of position under section 1092(d)(2), § 1.1092(d)-1(d) of the proposed regulations explicitly provides that an obligation under a debt instrument may be a position in personal property that is part of a straddle . . . Thus, in appropriate cases, the IRS may take the position under section 1092(d)(2) that, even in the absence of a regulation , an obligation under a debt instrument was part of a straddle prior to the effective date of § 1.1092(d)-1(d) if the debt instrument functioned economically as an interest in actively traded personal property (66 Fed. Reg . 4746, 4748). [Emphasis added.]

After it issued Prop. Regs. Sec. 1.1092-1(d), the IRS has taken positions that were consistent with the regulation, the most recent of which was provided in IRS legal memorandum ILM 201310027.

In ILM 201310027, a taxpayer issued debentures (the notes) that were exchangeable (the exchange feature) upon demand by a holder for shares of a corporation ( X ).

The X stock was publicly traded, and the taxpayer also held a specified amount of X stock. Immediately before the notes were issued, the trading price of X stock was less than the exercise price for the exchange feature (i.e., the exchange feature was “out of the money”).

Prior to the notes’ maturity, the exchange feature became “in the money” (i.e., the exercise price of the exchange feature was less than the trading price of X stock), and the taxpayer redeemed the notes for an amount of cash, which resulted in repurchase premium related to the notes under Regs. Sec. 1.163-7(c).

The IRS concluded that the interest related to the notes and the repurchase premium were required to be capitalized under Sec. 263(g) because the notes constituted an offsetting position to the taxpayer’s X stock (i.e., the notes and the X stock constituted a straddle). See also TAM 200509022, TAM 200530027, and TAM 200541040.

Debt-Straddle Regulation

In September 2013, the IRS issued Temp. Regs. Sec. 1.1092(d)-1T (T.D. 9635), which adopted Prop. Regs. Sec. 1.1092(d)-1.

The IRS stated in T.D. 9635 that the statute and the legislative history under Sec. 1092(d)(7) do not indicate that Congress intended that the straddle rules’ application to debt instruments was limited solely to Sec. 1092(d)(7).

The newly issued Temp. Regs. Sec. 1.1092(d)-1T(d) expires on Sept. 2, 2016, and applies to straddles established on or after Jan. 17, 2001.

Observation: The relevance of Temp. Regs. Sec. 1.1092(d)-1T(d) to the fact patterns in ILM 201310027, TAM 200509022, TAM 200530027, and TAM 200541040 was marginalized due to the expanded scope of Sec. 163(l) in the American Jobs Creation Act of 2004, P.L. 108-357. However, the issuance of Temp. Regs. Sec. 1.1092(d)-1T is significant because it could also affect an obligor’s debt that references personal property other than stock. For example, Temp. Regs. Sec. 1.1092(d)-1T may need to be considered by a taxpayer who issues a debt that may provide for contingent payments based on the price of a commodity that is actively traded.

Background to the Premixed Straddle Regulation

A “mixed straddle” under Temp. Regs. Sec. 1.1092(b)-5T(e) is a straddle (1) all of the positions of which are held as capital assets; (2) at least one (but not all) of the positions of which is a Sec. 1256 contract (as defined in Sec. 1256(b)); (3) for which an election under Sec. 1256(d) has not been made; and (4) that is not part of a larger straddle.

Gain or loss related to a Sec. 1256 contract is generally treated as capital under Sec. 1256(a)(3) with “60/40 treatment”: (1) 60% with a long-term holding period; and (2) 40% with a short-term holding period. Gain or loss related to a non-Sec. 1256 position that is part of a straddle is generally treated as short-term capital gain under Temp. Regs. Secs. 1.1092(b)-2T(a)(1) and 1.1092(b)-3T(b). However, special rules are provided in Temp. Regs. Secs. 1.1092(b)-3T(b)(2) through (7) for netting and determining the character for gain or loss for mixed straddles for which the taxpayer has made an election under Sec. 1092(b)(2) and Temp. Regs. Sec. 1.1092(b)-3T(d) (an “identified mixed straddle”).

Under Temp. Regs. Sec. 1.1092(b)-3T(b)(6), if one or more positions of an identified mixed straddle were held before such identified mixed straddle was established, those positions are deemed sold for their fair market value as of the close of the last business day preceding the day that the identified mixed straddle was established. In addition, Temp. Regs. Sec. 1.1092(b)-3T(b)(6) provides for an adjustment (to basis or otherwise) to any subsequent gain or loss recognized for those positions.

The regulation provides the following example to illustrate the treatment under Temp. Regs. Sec. 1.1092-3T(b)(6):

On January 1, 1985, A enters into a non-section 1256 position. As of the close of the day on July 9, 1985, there is $500 of unrealized long-term capital gain in the non-section 1256 position. On July 10, 1985, A enters into an offsetting section 1256 contract and makes a valid election to treat the straddle as a section 1092(b)(2) identified mixed straddle. Under these circumstances, on July 9, 1985, A will recognize $500 of long-term capital gain [a prestraddle gain] on the non-section 1256 position.

In addition, the regulation provides three other examples that illustrate the treatment under Temp. Regs. Sec. 1.1092(b)-3T(b)(6). However, each example curiously illustrates a circumstance resulting in a gain to the taxpayer; no example shows a taxpayer recognizing a loss.

The IRS clarified that this omission was not intended to prohibit a loss when it issued Field Service Advice (FSA) 1999-664, which provided that a taxpayer could recognize a “pre-straddle loss” under Temp. Regs. Sec. 1.1092-3T(b)(6). In the FSA, the taxpayer wanted to generate capital losses to offset substantial capital gains. To achieve this result, the taxpayer established an identified mixed straddle by entering into a short position in U.S. Treasury bonds to offset its long position in physical corporate bonds, and electing to establish an identified mixed straddle. As a result, the taxpayer claimed a prestraddle loss related to its long position. The IRS assumed for the FSA that the identified mixed straddle was in place for at least 31 days.

The IRS concluded in FSA 1999-664 that “substantial litigation hazards” existed with disallowing the taxpayer’s prestraddle loss, and that the regulations did not preclude the taxpayer from establishing identified mixed straddles with only those positions that would produce a capital loss. However, the IRS stated in a footnote:

We believe [an] argument could be made that the wash sale rules apply if taxpayer does not remain in a straddled position for 31 days. We would contend that there is a deemed disposition when taxpayer puts on a straddle and a deemed reacquisition when the straddle is taken off. Thus, if this occurs within a 30 day period, there is a wash sale. However, as indicated above, we have assumed for purposes of this memorandum that taxpayer remained in a straddle position for at least 31 days.

Premixed Straddle Regulation

In August 2013, the IRS issued temporary regulations under Temp. Regs. Secs. 1.1092(b)-3T and 1.1092(b)-6T (T.D. 9627), which changed the treatment of prestraddle gain and prestraddle loss related to identified mixed straddles.

Specifically, the newly issued Temp. Regs. Sec. 1.1092-6T provides that prestraddle gain and prestraddle loss are taken into account and have their character determined at the appropriate time by the provisions of the Code that would apply if the identified mixed straddle was not established under the Code. Changes in value of the positions that are a part of the identified mixed straddle are accounted for under Temp. Regs. Sec. 1.1092(b)-3T.

In the preamble to T.D. 9627, the IRS explained the reason for the changed treatment of prestraddle gain and prestraddle loss:

The approach taken in § 1.1092(b)-3T(b)(6) is suggested by the legislative history of section 1092, but it has come to the attention of the Treasury Department and the IRS that this paragraph arguably permits taxpayers to selectively recognize gains and losses in inappropriate circumstances and without market constraints . . . When taxpayers use the section 1092(b)(2) identified mixed straddle rules to serve as an alternative to selling or otherwise disposing of a position, the general rules governing when gain and loss are recognized are undermined.

The regulation provides the following example:

On August 13, year 2, A enters into a section 1256 contract. As of the close of the day on August 15, year 2, there is $500 of unrealized loss on the section 1256 contract. On August 16, year 2, A enters into an offsetting non-section 1256 position and makes a valid election to treat the straddle as [an identified mixed straddle]. A continues to hold both positions of the [identified mixed straddle] on January 1, year 3. Under these circumstances, A will recognize the $500 loss on the section 1256 contract that existed prior to establishing the [identified mixed straddle] on the last business day of year 2 because the section 1256 contract would be treated as sold on December 31, year 2 . . . under section 1256(a). The loss recognized in year 2 will be treated [with 60/40 treatment]. All gains and losses occurring after the [identified mixed straddle] is established are accounted for under the applicable provisions in § 1.1092(b)-3T.

The new regulations under Temp. Regs. Sec. 1.1092-6T initially applied to all identified mixed straddles established after Aug. 1, 2013. However, Treasury and the IRS received comments about this date and have since changed their applicability to identified mixed straddles established after the date that Temp. Regs. Sec. 1.1092-6T is finalized, which they intend to do no later than June 30, 2014 (Announcement 2013-44).


Greg Fairbanks is a tax senior manager with Grant Thornton LLP in Washington, D.C.

For additional information about these items, contact Mr. Fairbanks at 202-521-1503 or

Unless otherwise noted, contributors are members of or associated with Grant Thornton LLP.

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