§1258 — Title 26 Internal Revenue Code | U.S. Code

Summary

Some investment deals are built so that nearly all of the expected profit comes from the time value of the money invested, like interest on a loan, even though the deal is dressed up to produce capital gain. These are called conversion transactions. They include buying property while at the same time contracting to sell it at a set price, certain straddles, and deals marketed as turning interest-like returns into capital gains. When you close out a position in one of these deals, gain that would normally be capital gain is recharacterized under this rule up to an "applicable imputed income amount." That amount is the interest that would have built up on your net investment at 120 percent of the applicable federal rate, minus any amounts already recharacterized from earlier closeouts in the same deal. If a position already had a built-in loss when it joined the transaction, that loss keeps its original character. The rule does not apply to options dealers or commodities traders acting in the normal course of their business, though that exception can be lost for limited partners when the deal was marketed as a capital-gains play.

Title 26, §1258

Internal Revenue Code — Source: USLM XML via OLRC

(a)In the case of any gain—

(1)which (but for this section) would be treated as gain from the sale or exchange of a capital asset, and

(2)which is recognized on the disposition or other termination of any position which was held as part of a conversion transaction,

(b)For purposes of subsection (a), the term “applicable imputed income amount” means, with respect to any disposition or other termination referred to in subsection (a), an amount equal to—

(1)the amount of interest which would have accrued on the taxpayer’s net investment in the conversion transaction for the period ending on the date of such disposition or other termination (or, if earlier, the date on which the requirements of subsection (c) ceased to be satisfied) at a rate equal to 120 percent of the applicable rate, reduced by

(2)the amount treated as ordinary income under subsection (a) with respect to any prior disposition or other termination of a position which was held as a part of such transaction.

(c)For purposes of this section, the term “conversion transaction” means any transaction—

(1)substantially all of the taxpayer’s expected return from which is attributable to the time value of the taxpayer’s net investment in such transaction, and

(2)which is—

(A)the holding of any property (whether or not actively traded), and the entering into a contract to sell such property (or substantially identical property) at a price determined in accordance with such contract, but only if such property was acquired and such contract was entered into on a substantially contemporaneous basis,

(B)an applicable straddle,

(C)any other transaction which is marketed or sold as producing capital gains from a transaction described in paragraph (1), or

(D)any other transaction specified in regulations prescribed by the Secretary.

(d)For purposes of this section—

(1)The term “applicable straddle” means any straddle (within the meaning of section 1092(c)).

(2)The term “applicable rate” means—

(A)the applicable Federal rate determined under section 1274(d) (compounded semiannually) as if the conversion transaction were a debt instrument, or

(B)if the term of the conversion transaction is indefinite, the Federal short-term rates in effect under section 6621(b) during the period of the conversion transaction (compounded daily).

(3)(A)If any position with a built-in loss becomes part of a conversion transaction—

(i)for purposes of applying this subtitle to such position for periods after such position becomes part of such transaction, such position shall be taken into account at its fair market value as of the time it became part of such transaction, except that

(ii)upon the disposition or other termination of such position in a transaction in which gain or loss is recognized, such built-in loss shall be recognized and shall have a character determined without regard to this section.

(B)For purposes of subparagraph (A), the term “built-in loss” means the loss (if any) which would have been realized if the position had been disposed of or otherwise terminated at its fair market value as of the time such position became part of the conversion transaction.

(4)In determining the taxpayer’s net investment in any conversion transaction, there shall be included the fair market value of any position which becomes part of such transaction (determined as of the time such position became part of such transaction).

(5)(A)Subsection (a) shall not apply to transactions—

(i)of an options dealer in the normal course of the dealer’s trade or business of dealing in options, or

(ii)of a commodities trader in the normal course of the trader’s trade or business of trading section 1256 contracts.

(B)For purposes of this paragraph—

(i)The term “options dealer” has the meaning given such term by section 1256(g)(8).

(ii)The term “commodities trader” means any person who is a member (or, except as otherwise provided in regulations, is entitled to trade as a member) of a domestic board of trade which is designated as a contract market by the Commodity Futures Trading Commission.

(C)In the case of any gain from a transaction recognized by an entity which is allocable to a limited partner or limited entrepreneur (within the meaning of section 461(k)(4)), subparagraph (A) shall not apply if—

(i)substantially all of the limited partner’s (or limited entrepreneur’s) expected return from the entity is attributable to the time value of the partner’s (or entrepreneur’s) net investment in such entity,

(ii)the transaction (or the interest in the entity) was marketed or sold as producing capital gains treatment from a transaction described in subsection (c)(1), or

(iii)the transaction (or the interest in the entity) is a transaction (or interest) specified in regulations prescribed by the Secretary.

Notes & Related Subsidiaries

Editorial Notes

Amendments

2018—Subsec. (d)(5)(C). Pub. L. 115–141 substituted “section 461(k)(4)” for “section 464(e)(2)” in introductory provisions. 2004—Subsec. (d)(1). Pub. L. 108–357 struck out “; except that the term ‘personal property’ shall include stock” before period at end.

Statutory Notes and Related Subsidiaries

Effective Date

of 2004 AmendmentAmendment by Pub. L. 108–357 applicable to positions established on or after Oct. 22, 2004, see section 888(e) of Pub. L. 108–357, set out as a note under section 246 of this title.

Effective Date

Pub. L. 103–66, title XIII, § 13206(a)(3), Aug. 10, 1993, 107 Stat. 465, as amended by Pub. L. 104–188, title I, § 1703(n)(11), Aug. 20, 1996, 110 Stat. 1877, provided that: “The

Amendments

made by this subsection [enacting this section] shall apply to conversion transactions entered into after April 30, 1993.”

§1258 Recharacterization of Gain From Certain Financial Transactions

Summary

Title 26, §1258

Notes & Related Subsidiaries

Editorial Notes

Amendments

Statutory Notes and Related Subsidiaries

Effective Date

Effective Date

Amendments

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