7599 / How is a tax straddle taxed?

The tax treatment applicable to a tax straddle depends on the types of property that make up the positions in the straddle. It will also depend on whether substantially all of the taxpayer’s expected return from the investment is attributable to the time value of the taxpayer’s net investment in the transaction. (See the discussion of conversion transactions in Q 7602.) If the straddle is made up solely of IRC Section 1256 contracts (see Q 7593), it will be taxed as explained in Q 7604. If the straddle is a “mixed” straddle, it will be taxed according to the rules explained in Q 7605. If the straddle qualifies as an “identified tax straddle,” it is subject to the rules explained in Q 7606.

If none of the foregoing exceptions or elections applies or has been made, the straddle will generally be taxed under the loss deferral, wash sale, and short sale rules explained at Q 7600.Straddles are also subject to the requirement that interest and carrying charges allocable to property that is part of the straddle be capitalized.¹

The IRS has ruled privately that it may be permissible for a taxpayer to identify which shares of stock are part of a straddle and which shares are used as collateral for a loan using appropriately modified versions of Treasury Regulation Section 1.1012-1(c)(2) or Temporary Treasury Regulation Section 1.1092(b)-3T(d)(4) in order to establish that the shares that are part of the collar are not used as collateral for the loan.²

These rules apply to all “dispositions” of positions in a straddle regardless of whether such disposition is by sale, exchange, cancellation, lapse, expiration, or any other termination of interest with respect to a position.³ Apparently, “other terminations” would include exercise, delivery, assignment, and offset.

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1.   IRC § 263(g).