* An Attorney’s Opinion: Why that CPA is wrong on taxation as capital gains

[Don Paul]

* An Attorney’s Opinion: Why that CPA is wrong on taxation as capital gains

September 16, 2010 ·

Why that CPA is wrong on taxation as capital gains

Dear DD,

Thanks so much for all you do on this site. As a former attorney who hates misinformation (!!), not too long ago I posted what I am going to share here in response to someone else who had raised the very same issue about the paragraph quoted by the CPA from IRS publication 525 page 33 about capital gains treatment for personal foreign currency transactions.

It’s true that there is that one paragraph in that publication. The problem is that that paragraph does not define “personal transaction” and therefore becomes totally misleading for people who have bought foreign currency as an investment, because section 988 of the code defines “personal transaction” in a way that does not apply to us. And that little paragraph in publication 525 comes right out of section 988.

The definition of “Personal transaction” basically distinguishes between the traveler who happens to cash in excess currency from a trip and the person who buys foreign currency as an investment. According to section 988, when read in its entirety, the capital gains treatment is only for the person who did not purchase it as an investment, i.e., the traveler. As to the traveler types, it is considered as a “personal transaction,” under Section 988 which carves out a special exception for such transactions, and they are taxed only on any gain over $200 as capital gains.

However, in the very last part of section 988, the definition of “personal transactions” specifically EXCLUDES “any transfer to the extent that expenses properly allocable to such transaction meet the requirements of …section 212…”

Section 212 has to do with expenses related to the production of income, in other words, if the transaction involves expenses relating to the production of income, i.e., investment, the transaction is NOT considered to be a “personal transaction” under Section 988. Rather, it is an investment transaction. If someone has the dinars because they were actually in Iraq and had some left over that they’re now exchanging because they are not planning to go back to Iraq, that’s one thing. Although, even in that case, if they’ve been home in the US for 3 years now and have been holding on to their leftover dinars in anticipation of the RV, then it would appear that what was initially a “personal transaction” has now become an investment transaction.

Gains under Section 988 which are not “personal transactions” are taxed as ordinary income, and treated like interest.

Recently two tax attorneys and one CPA (the latter of whom who specializes in taxation of foreign currency trading transactions) have told me that the gains will be ordinary income under section 988, no matter how long a person has held them, not capital gains.

One of the attorneys that I had first consulted many months ago told me at that time that the gain would be treated as capital gains. When more recently I heard from these two other sources that it was all to be taxed as ordinary income under section 988, I contacted the first tax attorney again and explained that I had been given advice from other professionals that conflicted with his, and explained what they said, and asked if he could please either confirm his original advice or correct it. He corrected his.

So that is all to say that that one little paragraph in Publication 525 is correct as quoted, but unfortunately it fails to explain the very important point that “personal transaction” is a defined term in the code and it does not mean what we would like to think it means because our situation does not fit the exception it carves out for “personal transactions.”

So having said all that, perhaps you should share this information with your members so they can take both opinions to their own tax professional.

Thanks very much.

DDT Member

[C_BOLT]

Please see my previous post.

This confirms what was said in that post.

You treat this as ordinary gain or loss and will be taxed accordingly to the 60/40 rule.

Thanks for the post.

David

[rjboots1]

Thank you Don Paul and C-Bolt. I was told this same thing, and given a copy of the IRS tax code, by a tax attorney a few months ago, but have become less certain in recent weeks because of all the reports of people that have gotten conflicting info from their accountants about capital gains. I've actually presented this in the chat room a couple of times and been shot down by others. It's not something I want to take a chance on, given the magnitude of potential penalties and interest. Thanks for your help!!

[ExecConsult]

Please see my previous post.

This confirms what was said in that post.

You treat this as ordinary gain or loss and will be taxed accordingly to the 60/40 rule.

Thanks for the post.

David

David,

I need to correct you on one thing. Ordinary income does not (and can not) get the 60/40 treatment. That is only for Capital Gains elected under Section 1256. Since this is ordinary income under Section 988, it is treated as interest income and gets no special treatment at all. For more detail on this, you may want to see some of my other posts, but it sounds like you understand it pretty well.

Best,

Mark

* An Attorney’s Opinion: Why that CPA is wrong on taxation as capital gains

September 16, 2010 ·

Why that CPA is wrong on taxation as capital gains

Dear DD,

Thanks so much for all you do on this site. As a former attorney who hates misinformation (!!), not too long ago I posted what I am going to share here in response to someone else who had raised the very same issue about the paragraph quoted by the CPA from IRS publication 525 page 33 about capital gains treatment for personal foreign currency transactions.

It’s true that there is that one paragraph in that publication. The problem is that that paragraph does not define “personal transaction” and therefore becomes totally misleading for people who have bought foreign currency as an investment, because section 988 of the code defines “personal transaction” in a way that does not apply to us. And that little paragraph in publication 525 comes right out of section 988.

The definition of “Personal transaction” basically distinguishes between the traveler who happens to cash in excess currency from a trip and the person who buys foreign currency as an investment. According to section 988, when read in its entirety, the capital gains treatment is only for the person who did not purchase it as an investment, i.e., the traveler. As to the traveler types, it is considered as a “personal transaction,” under Section 988 which carves out a special exception for such transactions, and they are taxed only on any gain over $200 as capital gains.

However, in the very last part of section 988, the definition of “personal transactions” specifically EXCLUDES “any transfer to the extent that expenses properly allocable to such transaction meet the requirements of …section 212…”

Section 212 has to do with expenses related to the production of income, in other words, if the transaction involves expenses relating to the production of income, i.e., investment, the transaction is NOT considered to be a “personal transaction” under Section 988. Rather, it is an investment transaction. If someone has the dinars because they were actually in Iraq and had some left over that they’re now exchanging because they are not planning to go back to Iraq, that’s one thing. Although, even in that case, if they’ve been home in the US for 3 years now and have been holding on to their leftover dinars in anticipation of the RV, then it would appear that what was initially a “personal transaction” has now become an investment transaction.

Gains under Section 988 which are not “personal transactions” are taxed as ordinary income, and treated like interest.

Recently two tax attorneys and one CPA (the latter of whom who specializes in taxation of foreign currency trading transactions) have told me that the gains will be ordinary income under section 988, no matter how long a person has held them, not capital gains.

One of the attorneys that I had first consulted many months ago told me at that time that the gain would be treated as capital gains. When more recently I heard from these two other sources that it was all to be taxed as ordinary income under section 988, I contacted the first tax attorney again and explained that I had been given advice from other professionals that conflicted with his, and explained what they said, and asked if he could please either confirm his original advice or correct it. He corrected his.

So that is all to say that that one little paragraph in Publication 525 is correct as quoted, but unfortunately it fails to explain the very important point that “personal transaction” is a defined term in the code and it does not mean what we would like to think it means because our situation does not fit the exception it carves out for “personal transactions.”

So having said all that, perhaps you should share this information with your members so they can take both opinions to their own tax professional.

Thanks very much.

DDT Member

This is right on. The only thing that it leaves out is that you can not opt out of Section 988 to Section 1256 for Dinar investments like you could for many forex investments. You are stuck with it.