August.21.2013
On August 2, 2013, the IRS issued temporary regulations (the "Temporary Regulations") relating to accrued gain or loss associated with a position that becomes part of a section 1092(b)(2) identified mixed straddle.[1]The Temporary Regulations apply to positions established after August 1, 2013. The text of the Temporary Regulations also serves as the text of simultaneously issued proposed regulations.[2]Comments and discussion topic outlines for a public hearing on the proposed regulations, to be held December 4, are due by October 31.
Section 1092 sets forth the straddle rules. Under these rules, losses, arising from positions in personal property which are realized, are deferred to the extent of unrealized gain in offsetting positions.[3]The term "straddle" means offsetting positions with respect to personal property.[4]A taxpayer holds offsetting positions with respect to personal property if there is a substantial diminution of the taxpayer's risk of loss from holding any position with respect to personal property by reason of his holding one or more other positions with respect to personal property (whether or not of the same kind).[5]The term "personal property" means any personal property of a type which is actively traded.[6]A "position" means an interest (including a futures or forward contract or option) in personal property.[7]
Complex issues arise in "mixed straddles" when one of the positions in the straddle is a 1256 contract,[8]entitled to mark to market and 60/40 treatment,[9]and the other position is not. Section 1092(b)(2) directs the Department of Treasury to issue regulations with respect to mixed straddles in general and specifies that such regulations should provide that a taxpayer may offset gains and losses from positions which are part of mixed straddles either by straddle by straddle identification or by the establishment of a mixed-straddle account. Treasury Regulations sections 1.1092(b)-3T and 1.1092(b)-4T address gains and losses from positions which are part of mixed straddles.
The Temporary Regulations segregate pre-identification gain and loss on a mixed straddle position from post-identification gain and loss, preventing taxpayers from using identified mixed straddles as an alternative to selling assets to accelerate gain or loss. Prior to the issuance of the Temporary Regulations, Treasury Regulations section 1.1092(b)-3T(b)(6) provided that if one or more positions of a section 1092(b)(2) identified mixed straddle were held by the taxpayer on the day prior to the day the section 1092(b)(2) identified mixed straddle was established, such position or positions would be deemed sold for their fair market value as of the close of the last business day preceding the day such section 1092(b)(2) identified mixed straddle is established. The Temporary Regulations amend Treasury Regulations section 1.1092(b)-3T(b)(6) to limit the application of such section to positions established on or prior to August 1, 2013.
The approach of the prior regulations is supported by the legislative history of section 1092 and arguably permits taxpayers to selectively recognize gains and losses, however, it is the view of Treasury and the IRS that the current recognition treatment is merely "suggested" by the legislative history and not required. The Preamble to the Temporary Regulations includes the following statement:
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. Thus, for example, a taxpayer could seek to use the identified mixed straddle rules in § 1.1092(b)-3T(b)(6) to accelerate a loss on a position that could not be marked to market or easily disposed of. 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 Treasury Department and the IRS believe that it is appropriate to act promptly to prevent these types of transactions because they represent a use of section 1092 that was not intended.
To prevent these types of transactions, the Temporary Regulations add new Treasury Regulations section 1.1092(b)(2)-6T, which provides that, after August 1, 2013, any unrealized gain or loss with respect to a position or positions on the day prior to the day a section 1092(b)(2) identified mixed straddle is established is taken into account at the time, and has the character, provided by the provisions of the Code that would apply to such unrealized gain or loss if the section 1092(b)(2) identified mixed straddle were not established.[10]The Temporary Regulations illustrate the new rule using two examples.[11]The first example illustrates application of the rule when the existing position is a section 1256 contract and the second illustrates the rule when the preexisting position is not a section 1256 contract.
In Example 1, on August 13, 2013, A enters into a section 1256 contract. As of the close of the day on August 15, 2013, there is $500 of unrealized loss on the section 1256 contract. On August 16, 2013, A enters into an offsetting non-section 1256 position and makes a valid election to treat the straddle as a section 1092(b)(2) identified mixed straddle. A continues to hold both positions of the section 1092(b)(2) identified mixed straddle on January 1, 2014. Under these circumstances, according to the example, A will recognize the $500 loss on the section 1256 contract that existed prior to establishing the section 1092(b)(2) identified mixed straddle on the last business day of 2013 because the section 1256 contract would be treated as sold on December 31, 2013 (the last business day of the taxable year) under section 1256(a). The loss recognized in 2013 will be treated as 60% long-term capital loss and 40% short-term capital loss.
In Example 2, on September 3, 2012, A enters into a non-section 1256 position. As of the close of the day on August 22, 2013, there is $400 of unrealized short-term capital gain on the non-section 1256 position. On August 23, 2013, 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. On September 10, 2013, A closes out the section 1256 contract at a $500 loss and disposes of the non-section 1256 position, realizing an $875 gain. Under these circumstances, according to the example, A has $400 of short-term capital gain attributable to the non-section 1256 position prior to the day the section 1092(b)(2) identified mixed straddle was established. The $400 unrealized gain earned on the non-section 1256 position will be recognized on September 10, 2013, the date on which the non-section 1256 position is disposed. The gain will be short-term capital gain because, if the non-section 1256 position had been disposed of prior to establishing the section 1092(b)(2) identified mixed straddle, the gain would not have been long-term capital gain. On September 10, 2013, the gain of $875 on the non-section 1256 position will be reduced to $475 to take into account the $400 of unrealized gain when the section 1092(b)(2) identified mixed straddle was established. The $475 gain on the non-section 1256 position will be offset by the $500 loss on the section 1256 contract. The net loss of $25 from the straddle will be treated as 60% long-term capital loss and 40% short-term capital loss because it is attributable to the section 1256 contract.
The attention given to mixed straddles likely arises from recently proposed tax reform legislation, which contains its own provision relating to mixed straddles. [See Tax Law Update - House Ways & Means Proposals for Financial Products Tax Reform]. In the proposed legislation, a "mixed straddle" would be a straddle consisting of a derivative and a non-derivative effectively putting all derivatives on the mark-to-market regime.
The Temporary Regulations are bound to generate controversy. The legislative history clearly appears to support the treatment of pre-creation gain or loss under the prior regulations, which have been in force since 1985.
It is intended that the offset for gains and losses from mixed straddles under the regulations prescribed under the conference agreement may apply in cases where the taxpayer holds either section 1256 contracts or other positions before a mixed straddle is established. In such cases it is intended that the regulations will require the pre-straddle gains and losses accrued at the time the mixed straddle is created to be recognized at such time.[12]
The Temporary Regulations, on the other hand, appear contrary to the legislative history under section 1092. Thus, one can expect there to be a fair amount of criticism with respect to the Temporary Regulations, even in the light of recent cases such asMayo Foundation for Medical Education and Research v. United States,[13]apparently extending the scope of regulatory deference.
[1] T.D. 9627. All section references are to the Internal Revenue Code of 1986, as amended (the "Code"), unless otherwise specified.
[2] 78 F.R. 46807.
[3] Section 1092(a)(1)(A).
[4] Section 1092(c)(1).
[5] Section 1092(c)(2)(A).
[6] Section 1092(d)(1).
[7] Section 1092(d)(2).
[8] Section 1256 contracts include any of the following categories of contracts: (1) regulated futures contracts; (2) foreign currency contracts; (3) non-equity options; (4) dealer equity options; and (5) dealer securities futures contracts. Section 1256(b)(1). Section 1256 contracts do not include (1) any securities futures contract or option on such a contract unless such contract or option is a dealer securities futures contract, or (2) any interest rate swap, currency swap, basis swap, interest rate cap, interest rate floor, commodity swap, equity swap, equity index swap, credit default swap, or similar agreement. Section 1256(b)(2).
[9] Section 1256(a)(3).
[10] Treasury Regulations Section 1.1092(b)-6T(a).
[11] Treasury Regulations Section 1.1092(b)-6T(b).
[12] H.R. Conf. Rept. 98-861 at 912.
[13] 131 S. Ct. 704 (2011).