The IRS issued final regulations ( T.D. 9736) on Sept. 18 related to certain hedging transactions under Treas. Reg. Sec. 1.988-5. The final regulations replace temporary regulations without substantial change.
The final regulations allow, under Treas. Reg. Sec. 1.988-5, for the integration of a qualifying debt instrument (QDI) and a hedge if certain requirements are met. The QDI must meet the definition under Treas. Reg. Sec. 1.988-5(a)(3), and a hedge must meet the definition under Treas. Reg. Sec. 1.988-5(a)(4). If a transaction qualifies, the QDI and the hedge are integrated and treated as a single transaction under Treas. Reg. Sec. 1.988-5(a)(9). Neither the QDI nor the hedge is subject to the straddle rules (Sections 263(g) or 1092) or Section 1256 during the period in which the transactions are integrated.
The final regulations provide for the treatment of an integrated transaction when the taxpayer disposes of or otherwise terminates all or a portion of the QDI or the hedge before maturity (also known as "legging out").
The final regulations generally provide that when all components of the hedge have been disposed of, the QDI is treated as sold or terminated by the taxpayer for its fair market value, and any gain or loss is realized and recognized. Also, when the hedge has more than one component and at least one, but not all, of the components have been disposed of, the QDI is treated as sold or terminated for its fair market value and all remaining components that have not been disposed of are treated as sold for their fair market value, and any gain or loss is realized and recognized. And finally, when the QDI is disposed of or terminated in whole or in part, the hedge is treated as sold or terminated for its fair market value, and any gain or loss is realized and recognized.
The regulations state an exception to the general rules if the taxpayer realizes net gain but enters certain transactions that hedge at least 50% of the remaining currency flow within a specified period.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
