7617 / What is an "appreciated financial position"?

For purposes of the constructive sales rules of IRC Section 1259, an appreciated financial position is any position with respect to any stock, debt instrument, or partnership interest if there would be a gain were the position sold, assigned, or otherwise terminated at its fair market value.¹ The term “position” is further defined as an interest, including a futures or forward contract (see Q 7588 to Q 7592), a short sale (see Q 7524 to Q 7535), or an option (see Q 7556 to Q 7581).² Furthermore, it was the intent of Congress that offsetting notional principal contracts (see Q 7621) also be included in the definition of “appreciated financial position,” and such a definition is supported by the language of IRC Section 1259(c)(1)(D).³

An interest in a trust that is actively traded will be treated as stock, for purposes of determining whether it is an appreciated financial position, unless substantially all (by value) of the property held by the trust is debt that qualifies for the debt interest exception described below.⁴

Debt instrument exception. The term “appreciated financial position” does not include any position with respect to debt (e.g., bonds) if: (1) the position unconditionally entitles the holder to receive a specified principal amount; (2) the interest payments (or other similar amounts) with respect to such position are payable at a fixed rate or, to the extent provided in regulations, at a variable rate; and (3) such position is not convertible (directly or indirectly) into stock of the issuer or any related person (see Q 7618).⁵ Furthermore, the term “appreciated financial position” does not include any hedge of a position satisfying all three of the foregoing requirements.⁶

Consequently, to qualify for the exception for a position with respect to debt instruments, the position itself would have to either meet the requirements as to unconditional principal amount, nonconvertibility, and interest terms or, alternatively, be a hedge of a position meeting these requirements. A hedge for purposes of this provision includes any position that reduces the taxpayer’s risk of interest rate or price changes or currency fluctuations with respect to another position.⁷

Mark to market exception. The term “appreciated financial position” does not include any position that is marked to the market (see Q 7592).⁸