7604. How is a “conversion transaction” treated for income tax purposes?Nuco Employeercline202014-10-01T14:44:00Z2014-10-01T14:44:00Z47474264Case Western Reserve University3510500114Site Map/Investments/Special Rules/Conversions, Constructive Sales, Constructive Ownership/Conversion TransactionsTaxFactsDefaultArticle2006-01-04T00:00:00Z121171086-00-tf2.xml1086.00;#1947;#0x010100C568DB52D9D0A14D9B2FDCC96666E9F2007948130EC3DB064584E219954237AF3900242457EFB8B24247815D688C526CD44D009C4E67E972694125ABDA91AC61F5E51FTax Facts 2How is a “conversion transaction” treated for income tax purposes?
46300.0000000000TaxFactsDefaultArticleSBMEDIA\moss-admin2010-01-14T23:02:55Z7604. How is a “conversion transaction” treated for income tax purposes?In general, any gain that would otherwise be treated as gain from the sale or exchange of a capital asset and that is recognized on the disposition or other termination of any position held as part of a conversion transaction (see Q 7603) will be treated as ordinary income to the extent that such gain does not exceed an “applicable imputed income amount,” as defined below.IRC Sec. 1258(a). The purpose of IRC Section 1258 is to prevent the use of conversion transactions to transform ordinary income into capital gain.“Applicable imputed income amount” (for purposes of a disposition or termination of a conversion transaction) means the amount of interest that would have accrued on the taxpayer’s net investment in the conversion transaction for the period ending on the date of such disposition (or on the date the transaction ceased to be a conversion transaction, if earlier) at a rate equal to 120 percent of the applicable rate (see below) reduced by any amounts previously treated as ordinary income under IRC Section 1258.IRC Sec. 1258(b). Future regulations will provide for reduction of the applicable imputed income amount for amounts capitalized under IRC Section 263(g). A taxpayer’s net investment in a conversion transaction includes the fair market value of any position that becomes part of the transaction.IRC Sec. 1258(d)(4).The term “applicable rate” refers to the applicable federal rate as determined under IRC Section 1274(d) (compounded semiannually) as if the conversion transaction were a debt instrument, or, if the term of the conversion transaction is indefinite, the federal short-term rates in effect under IRC Section 6621(b) (relating to the determination of interest rates for overpayments and underpayments of tax) during the period of the conversion transaction (compounded daily).IRC Sec. 1258(d)(2).Regulations provide taxpayers with a method to net certain gains and losses from positions of the same conversion transaction before determining the amount of gain treated as ordinary income.Treas. Reg. §1.1258-1(a). If a taxpayer disposes of or terminates all the positions of an “identified netting transaction” within a 14 day period in a single taxable year, all gains and losses on those positions realized within that period (other than built-in losses, see below) are netted solely for purposes of determining the amount of gain treated as ordinary income. An “identified netting transaction” is a conversion transaction that the taxpayer identifies as an identified netting transaction on its books and records. Identification of each position of the conversion transaction must be made before the close of the business day on which the position becomes part of the conversion transaction.Treas. Reg. §1.1258-1(b).A position with a “built-in” loss that becomes part of a conversion transaction is taken into account at its fair market value, determined as of the date the position becomes part of the conversion transaction; but upon disposition or other termination of the position (in a transaction in which gain or loss is realized), the built-in loss will be recognized and its character will be determined without regard to IRC Section 1258.IRC Sec. 1258(d)(3). Thus, if a position with a built-in capital loss becomes part of a conversion transaction, upon a disposition of the position the built-in loss will retain its character as a capital loss for purposes of IRC Section 1258. “Built-in loss” means any loss that would have been realized if the position had been disposed of or otherwise terminated at its fair market value as of the time the position became a part of the conversion transaction.IRC Sec. 1258(d)(3)(B). A “built-in loss” can also arise if a taxpayer realizes a gain or loss on any one position of a conversion transaction and, as of the date that gain or loss is realized, there is unrealized loss in any other position of the conversion transaction that is not disposed of, terminated, or treated as sold under any provision of the IRC or regulations within 14 days of and within the same taxable year as the realization event.Treas. Reg. §1.1258-1(c).Although built-in loss is not recharacterized for purposes of IRC Section 1258, it appears that property with a built-in gain will not be afforded the same treatment. IRC Section 1258(a) states that any capital gain that is recognized on the disposition of a position held as part of a conversion transaction will be recharacterized as ordinary income to the extent the gain does not exceed the applicable imputed income amount. Thus, it seems that gain generated prior to property’s inclusion in a conversion transaction is subject to recharacterization.The conversion transaction rules do not apply to the transactions of an options or commodities dealer entered into in the normal course of business; but limited partners and certain investors who have an interest in an enterprise other than as a limited partner will generally be subject to the conversion transaction rules.IRC Sec. 1258(d)(5).