Final sec. 246 and 1092 regulations create new straddle positions.

• Author: Kanovsky, Sharon R.

The dividends received deduction (DRD) for corporations is disallowed under Sec. 246(c) if the holding period for the stock with respect to which the dividends are received is less than 46 days (91 days for certain preferred stock). Sec. 246(c)(3) provides the holding period must be reduced by any period during which the taxpayer's risk of loss with respect to the stock is diminished because the taxpayer

--has an option to seel, is under contract to seel or has made (and not closed) a short sale of substantially identical stock or securities;

--has granted an option to purchase substantially identical stock or securities; or

--has reduced the risk by holding one or more other positions with respect to substantially similar or related property.

The IRS recently issued final regulations under Sec. 246, prescribing when, for purposes of the DRD, a taxpayer must reduce its holding period of stock because it has diminished its risk of loss by holding a position in substantially similar property. The final regulations also provide that the definition of "substantially similar or related property" for purposes of the DRD applies under the Sec. 1092 straddle rules.

By way of background, Regs. Sec. 1.246-5(b)(1) defines "property" as substantially similar or related to stock if the property and the stock primarily reflect the performance of a single firm or enterprise, the same industry or industries, or the same economic fact or factors (e.g., interest rates, commodity prices, foreign currency exchange prices, etc.) and changes in the stock's fair market value (FMV) are reasonably expected to approximate, directly or inversely, changes in the property's FMV. A taxpayer has diminished its risk of loss if changes in the stock's FMV and the position with respect to substantially similar or related property are reasonably expected to vary inversely. Whether offsetting positions constitute substantially similar or related property is determined based on the facts and circumstances of each case.

The final regulations prescribe rules for determining whether property is substantially similar or related. For example, investments in notional principal contracts (swaps), guarantees, surety agreements, certain out-of-the-money options and other similar arrangements may be considered positions in substantially similar or related property.

In addition, positions reflecting the value of a portfolio of stocks will be treated as substantially similar or related to...