The Broad But Porous Net of the Straddle Rules: How Long Will the Fish Continue to Swim Through?

Abstract

The straddle rules, designed to defer losses on one position in actively traded personal property when an offsetting position has unrecognized gains, have been adapted and expanded by the IRS to attack a number of abuses. This versatility has lead to an uneven evolution, and the rules have become highly specific as to some types of transactions, such as those involving offsetting positions in exchange-traded instruments. In other situations, such as those involving positions offsetting to a portfolio of stocks (which can arise, for instance, when a taxpayer holds stock index options or forwards), the rules are extraordinarily complex (involving both the regulations on straddles and those concerning the dividends-received deduction) and many taxpayers and IRS exam agents can be unaware that straddles are present. Even where offsetting positions are clearly present, such as with structured notes, practitioners can have radically different viewpoints as to whether the straddle rules should apply. This article reviews a number of examples where straddles may be difficult to detect, and suggests that the only effective simplification may require the introduction of a broader mark-to-market system.