7623 / How is a “constructive ownership transaction” treated for tax purposes?
For purposes of the constructive ownership transaction rules, net underlying long-term capital gain means the aggregate net capital gain that the taxpayer would have had if (1) the financial asset had been acquired for fair market value on the date the transaction was opened and sold for fair market value on the date the transaction was closed; and (2) only gains and losses that would have resulted from the deemed ownership under (1) were taken into account. If the taxpayer does not establish the amount of the net underlying long-term capital gain with respect to any financial asset by clear and convincing evidence, the amount of such gain will be treated as zero.2
If any gain is treated as ordinary income for any taxable year on account of these rules, the tax imposed for that year is increased by imposing interest at the underpayment rate for every prior tax year in which any portion of the constructive ownership transaction was open.3 The calculation of the interest is explained in IRC Section 1260(b)(2). No credits are allowed against the increase in tax.4
To the extent that gain is treated as long-term capital gain after the application of IRC Section 1260(a)(1) (i.e., instead of being recharacterized as ordinary income), it will be subject to the capital gain tax in the same manner as is the net underlying long-term capital gain.5 See Q 702 for the treatment of capital gains and losses.