If the taxpayer has gain from a constructive ownership transaction with respect to any financial asset and such gain would (without regard to this section) be treated as a long-term capital gain—
(1) such gain shall be treated as ordinary income to the extent that such gain exceeds the net underlying long-term capital gain, and
(2) to the extent such gain is treated as a long-term capital gain after the application of paragraph (1), the determination of the capital gain rate (or rates) applicable to such gain under section 1(h) shall be determined on the basis of the respective rate (or rates) that would have been applicable to the net underlying long-term capital gain.
If any gain is treated as ordinary income for any taxable year by reason of subsection (a)(1), the tax imposed by this chapter for such taxable year shall be increased by the amount of interest determined under paragraph (2) with respect to each prior taxable year during any portion of which the constructive ownership transaction was open. Any amount payable under this paragraph shall be taken into account in computing the amount of any deduction allowable to the taxpayer for interest paid or accrued during such taxable year.
The amount of interest determined under this paragraph with respect to a prior taxable year is the amount of interest which would have been imposed under section 6601 on the underpayment of tax for such year which would have resulted if the gain (which is treated as ordinary income by reason of subsection (a)(1)) had been included in gross income in the taxable years in which it accrued (determined by treating the income as accruing at a constant rate equal to the applicable Federal rate as in effect on the day the transaction closed). The period during which such interest shall accrue shall end on the due date (without extensions) for the return of tax imposed by this chapter for the taxable year in which such transaction closed.
For purposes of paragraph (2), the applicable Federal rate is the applicable Federal rate determined under section 1274(d) (compounded semiannually) which would apply to a debt instrument with a term equal to the period the transaction was open.
Any increase in tax under paragraph (1) shall not be treated as tax imposed by this chapter for purposes of determining—
(A) the amount of any credit allowable under this chapter, or
(B) the amount of the tax imposed by section 55.
For purposes of this section—
The term "financial asset" means—
(A) any equity interest in any pass-thru entity, and
(B) to the extent provided in regulations—
(i) any debt instrument, and
(ii) any stock in a corporation which is not a pass-thru entity.
For purposes of paragraph (1), the term "pass-thru entity" means—
(A) a regulated investment company,
(B) a real estate investment trust,
(C) an S corporation,
(D) a partnership,
(E) a trust,
(F) a common trust fund,
(G) a passive foreign investment company (as defined in section 1297 without regard to subsection (d) thereof), and
(H) a REMIC.
For purposes of this section—
The taxpayer shall be treated as having entered into a constructive ownership transaction with respect to any financial asset if the taxpayer—
(A) holds a long position under a notional principal contract with respect to the financial asset,
(B) enters into a forward or futures contract to acquire the financial asset,
(C) is the holder of a call option, and is the grantor of a put option, with respect to the financial asset and such options have substantially equal strike prices and substantially contemporaneous maturity dates, or
(D) to the extent provided in regulations prescribed by the Secretary, enters into one or more other transactions (or acquires one or more positions) that have substantially the same effect as a transaction described in any of the preceding subparagraphs.
This section shall not apply to any constructive ownership transaction if all of the positions which are part of such transaction are marked to market under any provision of this title or the regulations thereunder.
A person shall be treated as holding a long position under a notional principal contract with respect to any financial asset if such person—
(A) has the right to be paid (or receive credit for) all or substantially all of the investment yield (including appreciation) on such financial asset for a specified period, and
(B) is obligated to reimburse (or provide credit for) all or substantially all of any decline in the value of such financial asset.
The term "forward contract" means any contract to acquire in the future (or provide or receive credit for the future value of) any financial asset.
For purposes of this section, in the case of any constructive ownership transaction with respect to any financial asset, the term "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 such transaction was opened and sold for fair market value on the date such transaction was closed, and
(2) only gains and losses that would have resulted from the deemed ownership under paragraph (1) were taken into account.
The amount of the net underlying long-term capital gain with respect to any financial asset shall be treated as zero unless the amount thereof is established by clear and convincing evidence.
Except as provided in regulations prescribed by the Secretary, if a constructive ownership transaction is closed by reason of taking delivery, this section shall be applied as if the taxpayer had sold all the contracts, options, or other positions which are part of such transaction for fair market value on the closing date. The amount of gain recognized under the preceding sentence shall not exceed the amount of gain treated as ordinary income under subsection (a). Proper adjustments shall be made in the amount of any gain or loss subsequently realized for gain recognized and treated as ordinary income under this subsection.
The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this section, including regulations—
(1) to permit taxpayers to mark to market constructive ownership transactions in lieu of applying this section, and
(2) to exclude certain forward contracts which do not convey substantially all of the economic return with respect to a financial asset.
(Added Pub. L. 106–170, title V, §534(a), Dec. 17, 1999, 113 Stat. 1931; amended Pub. L. 108–357, title IV, §413(c)(23), Oct. 22, 2004, 118 Stat. 1509; Pub. L. 110–172, §11(a)(23), (24)(B), Dec. 29, 2007, 121 Stat. 2486.)
2007—Subsec. (c)(2)(G). Pub. L. 110–172 substituted "subsection (d)" for "subsection (e)" and inserted "and" at end.
2004—Subsec. (c)(2)(H) to (J). Pub. L. 108–357 redesignated subpar. (J) as (H) and struck out former subpars. (H) and (I), which included foreign personal holding company and foreign investment company (as defined in section 1246(b)) within definition of "pass-thru entity".
Amendment by Pub. L. 108–357 applicable to taxable years of foreign corporations beginning after Dec. 31, 2004, and to taxable years of United States shareholders with or within which such taxable years of foreign corporations end, see section 413(d)(1) of Pub. L. 108–357, set out as an Effective and Termination Dates of 2004 Amendments note under section 1 of this title.
Pub. L. 106–170, title V, §534(c), Dec. 17, 1999, 113 Stat. 1934, provided that: "The amendments made by this section [enacting this section] shall apply to transactions entered into after July 11, 1999."
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