Federal Tax

Financial Instruments: Special Rules (Portfolio 186)

  • This Portfolio examines the taxation of financial instruments and addresses two levels of analysis, the rules that override them, their application, and the problems that inspired them.


Bloomberg Tax Portfolio 186 T.M., Financial Instruments: Special Rules, considers the taxation of financial instruments, which is especially challenging because it requires two levels of analysis. First, one must establish the tax treatment of a particular instrument in isolation. This is no easy task because the rules are inconsistent, such that economically comparable transactions are taxed differently. But once this threshold inquiry is conducted, a second analysis is needed. Special rules apply, for instance, when two or more instruments have a specified relationship to each other: One instrument might serve to “hedge” — that is, reduce risk of loss in — the other. In other cases, one instrument might replace or substitute for another.

This Portfolio describes four special rules that override this usual treatment: the wash sale rules of §1091, the conversion transaction rules of §1258, the constructive sale rules of §1259, and the constructive ownership rules of §1260.

These special rules apply when an instrument bears a specified relationship to a formally separate instrument. These rules combine distinct transactions into one mega-transaction with its own tax treatment. These rules are designed to prevent a tax-motivated abuse. For each regime, this Portfolio discusses the problem that inspired Congress or the Treasury Department to promulgate the rule. The regime itself is then analyzed. Key issues are highlighted, and examples illustrate nuances in the rule and frequently-encountered issues of construction. In addition, there are discussions of various business and regulatory realities that feature prominently in these transactions, such as accounting rules, dynamic hedging, and the like.

Table of Contents

I. Wash Sales Under §1091
II. Conversion Transactions Under §1258
III. Constructive Sales Under §1259
IV. Constructive Ownership Under §1260

David Schizer
American Jewish Joint Distribution Committee
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