§1260 Gains from constructive ownership transactions

Summary

If you get a gain from a deal that acts like you owned a financial asset, some or all of that gain must be taxed as ordinary income instead of as a long-term capital gain. The amount treated as ordinary income is whatever part of the gain is more than the “net underlying long-term capital gain.” Any part left as long-term gain uses the same capital gain rate that would have applied to the net underlying long-term capital gain. If some gain is reclassified as ordinary, you also must pay interest for earlier years while the deal was open. That interest is figured like an underpayment under section 6601, using the applicable Federal rate in section 1274(d) (compounded semiannually) and stops on the tax return due date (no extensions) for the year the deal closed. The rule does not apply if all positions in the deal are marked to market under tax rules. If the deal ends by taking delivery, it is treated as if you sold the positions at fair market value on the closing date, but any gain recognized this way can’t be more than the ordinary income amount above. The Treasury can make rules to let taxpayers mark to market instead or to exclude certain forward contracts. Definitions (one line each): financial asset — equity in a pass‑thru entity and, by rule, some debt or corporate stock; pass‑thru entity — things like RICs, REITs, S corporations, partnerships, trusts, common trust funds, certain foreign investment companies, and REMICs; constructive ownership transaction — transactions that give you the economic effect of owning the asset (examples: certain notional principal contracts, forward or futures contracts, paired call and put options, or other similar deals); long position under a notional principal contract — having the right to most of the asset’s yield and the duty to cover most declines; forward contract — an agreement to get an asset or its future value.