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Financial Planning / Tax Strategies
|Subject: Re: Substantially Identical Property||Date: 7/18/1999 11:21 PM|
|Author: TMFTaxes||Number: 17456 of 124591|
[[I have been reading your series of articles with interest regarding realized gains,
e.g. shorting the box, buying a put against a position, etc. all cause a realized
I hope that you have enjoyed the series.
[[ Now I have a question on the concept of a "substantially equal security" ---
particularly as it realates to arbitrage plays --- ]]
And I discuss some of those issue in Part IV of my series. There are a lot of complicated issues out there...and the IRS has not provided any quidance. So it can get pretty dicey.
[[let's say that A is buying B on a
one-to-one basis; I buy 1000 shares of B and either 1. sell short 1000 shares of
A or 2. buy 10 put contracts on A; obviously & fully intending to make money
on the spread between A & B at no risk to me other than the potential that the
deal between A & B falls apart. Assuming that the deal remains open through a
year-end; have I realized a gain buyt selling a substantially equal security???
I personally think the answer is no, because of the continuing risk that A may not
buy B until such time as the deal is approved by both sets of shareholders or
maybe not until actualization of the sale & exchange of shares; however, I am
I'll tell you what...I am equally unsure. And I will remain unsure until the Treasury give us regulations on this issue. But instead of pontificating, and since you have been a long and distinguished member of the Tax Strategies message folder community, I'm going to give you a sneak preview of Part IV of the series. I think that it may help to answer your question.
Constructive Sales - Finis
In the last three weeks we've discussed various issues regarding the new constructive sales rules. If you've missed those articles, you might want to take the time and read them…just to get up to speed.
Moving forward, there are still a few items to review. While we have focused on the "short against the box" strategy in prior articles, there are other ways that a "long" position can be hedged. Many investors use other transactions in order to hedge their positions. And the question then becomes: "Do the constructive sale rules impact the use of these other financial transactions to hedge a position?" The answer is no. Or yes. Or even maybe. I guess the best answer is: It all depends.
I'm personally waiting for the regulations from IRS on this very issue. Those regulations will address these issues and how they relate to constructive sales. They'll also likely provide specific examples for various financial transactions. But as of this date, those regulations are still not published. So, since the regulations are not yet available, the best source of information would be the General Explanation of Tax Legislation (commonly referred to as the "Blue Book"), which was prepared by the Staff of the Joint Committee on Taxation in consultation with the staffs of the House Committee on Ways and Means and Senate Committee on Finance. If you are really interested in this subject, you should read then entire text at: http://www.house.gov/ways_means/publica.htm
(You'll want to look for the 1997 Joint Committee on Taxation Blue Book--General Explanation of Tax Legislation Enacted in 1997, JCS-23-97, December 17, 1997). It's some long reading, but you should be able to find the appropriate section (Part II, Title X, under the heading "Revenue Increase Provisions).
Remember that the constructive sale rules were implemented to stop transactions that had the effect of eliminating substantially all of your risk of loss AND opportunity for income and gain with respect to the appreciated financial position. That's the standard and it's very clear. Applying this reasoning, the Congress intended that transactions that reduce ONLY risk of loss or ONLY opportunity for gain would NOT be covered under the constructive sale rules.
Example: You hold an appreciated financial position in stock. You then enter into a "put" with an exercise price equal to the current market price (an "at the money" option). Because such an option reduces ONLY your risk of loss, and not your opportunity for gain, the above standard would not be met, and this would NOT be considered a constructive sale transaction. Again, remember that the transactions that the constructive sale rules impact are those that reduce BOTH risk of loss AND opportunity for gain. So if you hedge only one end of the transaction, the constructive sale rules wouldn't apply.
But there are other financial positions that may be impacted. One of them would be what is commonly called a "collar". In a collar, you commit to an option that requires you to sell a financial position at a fixed price (the "call strike price") and have the right to have your position purchased at a lower fixed price (the "put strike price").
Example: You enter into a collar for a stock currently trading at $100 with a put strike price of $95 and a call strike price of $110. The effect of the transaction is that you have transferred the rights to all gain above the $110 call strike price and all loss below the $95 put strike price. But…you have retained all risk of loss and opportunity for gain in the price range between $95 and $110. A collar can be a single contract or can be effected by using a combination of put and call options. So while your gain AND loss is eliminated above $110 and below $95, your gain OR loss is alive and well between those two prices. Constructive sale?
Based upon what we know, it's difficult to say if a collar will be treated as a constructive sale. The Congress anticipates that Treasury regulations will provide specific standards that take into account various factors with respect to the appreciated financial position, including its volatility. You can certainly expect that the regulations will review several aspects of the collar transaction. Important issue will include the spread between the put and call prices, the period of the transaction, and the extent to which the taxpayer retains the right to periodic payments on the appreciated financial position (such as the dividends on collared stock). So is YOUR collar (which may be substantially different that mine) a constructive sale? That's up to you, your God, and the IRS (and likely your tax pro)...and your collective interpretation of the IRS code. And this is one of the reasons that we are waiting for the regulations.
Another common transaction for which regulations would be helpful is a so-called "in-the-money" op