Letter ruling addresses timing issue for nonidentified hedging transactions.

• Author: Gregory, James E.

In Letter Ruling 9706002, the IRS considered whether the timing rules of Regs. Sec. 1.446-4(a) apply to a "hedging transaction" under Regs. Sec. 1.1221-2(b) that the taxpayer failed to identify as such under Regs. Sec. 1.1221-2(e).

The taxpayer in the ruling entered into a forward rate agreement and two interest-rate swap agreements, to protect against increases in interest rates and to "lock in" its obligations on a proposed fixed-rate debt instrument. The taxpayer intended to treat the transaction as a "hedging transaction" under Regs. Sec. 1.1221-2(b) and to account for the transaction in accordance with the Regs. Sec. 1.446-4(e) (4) timing rules, However, contrary to the requirements of Regs. Sec. 1.1221-2(e), the taxpayer neglected to identify the agreements as hedging transactions for tax purposes in its books and records on the date of such agreements, and failed to identify specifically the proposed issuance of debt as the hedged item within 35 days of the date of the agreements.

The significance of identifying a transaction as a "hedging transaction" under Regs. Sec. 1.1221-2(e) is that such identification is binding with respect to the character of any gains realized on the transaction (i.e., gains would be ordinary). An identification is not necessarily binding, however, for any losses resulting from such transaction. Under Regs. Sec. 1.1221-2(f)(2), if there is no identification, the transaction generally will not be treated as a hedging transaction. A taxpayer may nevertheless receive ordinary gain or loss treatment despite its failure to identify such transaction as a hedging transaction, if the following requirements are satisfied: (1) the transaction is otherwise within the definition of a hedging transaction under Regs. Sec. 1.1221-2(b), (2) the failure to identify such transaction as a hedging transaction was due to "inadvertent error" and (3) all of the taxpayer's hedging transactions in all open years are treated on either original or amended tax returns (if necessary) consistently with the principles of Regs. Sec. 1.1221-2.

Regs. Sec. 1.446-4(a) provides that the timing of income and other items from "hedging transactions" defined in Regs. Sec. 1.1221-2(b) is determined thereunder whether or not the character is determined under Regs. Sec. 1.1221-2. Regs. Sec. 1.446-4(b) provides...