# Prop. Treas. Reg. § 1.263(g)-4: Rules for allocating amounts to personal property that is part of a straddle. Proposed regulation, not in force. REG-105801-00, 66 FR 4746, published 2001-01-18 . Interprets 26 U.S.C. § 263. Par. 2. Sections 1.263(g)-1, 1.263(g)-2, 1.263(g)-3, 1.263(g)-4, and 1.263(g)-5 are added to read as follows: (a) Allocation rules. (1) Interest and carrying charges paid or accrued on indebtedness or other financing issued or continued to purchase or carry personal property that is part of a straddle are allocated, in the order listed— (i) To personal property that is part of the straddle purchased, directly or indirectly, with the proceeds of the indebtedness or other financing; (ii) To personal property that is part of the straddle and directly or indirectly secures the indebtedness or other financing; or (iii) If all or a portion of such interest and carrying charges are determined by reference to the value or change in value of personal property, to such personal property. (2) Fees and expenses described in § 1.263(g)-3(b)(2) are allocated to the personal property, the acquisition or holding of which resulted in the fees and expenses being paid or incurred. (3) In all other cases, interest and carrying charges are allocated to personal property that is part of a straddle in the manner that under all the facts and circumstances is most appropriate. (b) Coordination with other provisions. In the case of a short sale, section 263(g) applies after section 263(h). See sections 263(g)(4)(A) and (h)(6). In case of an obligation to which section 1277 (dealing with deferral of interest deduction allocable to accrued market discount) or 1282 (dealing with deferral of interest deduction allocable to certain accruals on short-term indebtedness) applies, section 263(g) applies after section 1277 and section 1282. See section 263(g)(4)(B). Capitalization under section 263(g) applies before loss deferral under section 1092. (c) Examples. The following examples illustrate the rules stated in §§ 1.263(g)-2, 1.263(g)-3, and 1.263(g)-4. Example 1 . Cash and Carry Silver. (i) Facts. On January 1, 2002, A borrows $ x at 6% interest and uses the proceeds to purchase y ounces of silver from B . At approximately the same time, A enters into a forward contract with C to deliver y ounces of silver to C in one year. (ii) Analysis. The y ounces of silver and the forward contract to deliver y ounces of silver in one year are offsetting positions with respect to the same personal property and therefore constitute a straddle. See sections 1092(c)(1), (c)(3)(A)(i). The proceeds of the debt instrument were used to purchase personal property that is part of the straddle. Consequently, A 's interest payments are interest and carrying charges properly allocable to personal property that is part of a straddle. See § 1.263(g)-3(b)(1) & (c)(1). Under § 1.263(g)-4(a)(1)(i), the interest payments must be charged to the capital account for the y ounces of silver purchased by A with the proceeds of the borrowing. Example 2. Additional indebtedness issued to carry personal property. (i) Facts. The facts are the same as for Example 1 except that during the year 2002, the market price of silver increases and A is required to post variation margin as security for its obligation to deliver y ounces of silver to C . A incurs additional indebtedness to obtain funds necessary to meet A 's variation margin requirement. (ii) Analysis. The additional indebtedness is incurred to continue to carry A 's holding of z ounces of silver. Consequently, A 's interest payments on the additional indebtedness are interest and carrying charges properly allocable to personal property that is part of a straddle and must be charged to the capital account for the y ounces of silver. Example 3 . Contingent payment debt instrument. (i) Facts. On January 1, 2002, D enters into a contract to deliver x barrels of fuel oil to E on July 1, 2004, at an aggregate price equal to $ y . Soon afterward, D issues a contingent payment debt instrument to F with a principal amount of $ z and a 2-year term that pays interest quarterly at a rate determined at the beginning of each quarter equal to the greater of zero and the London Interbank Offered Rate (LIBOR) adjusted by an index that varies inversely with changes in the price of fuel oil (so that the interest rate increases as the price of fuel oil decreases and vice versa). The change in the aggregate amount of interest paid on the $ z of debt due to the functioning of the index approximates the concurrent aggregate change in value of x barrels of fuel oil and, thus, the value of D 's interest in the forward contract. (ii) Analysis. The debt instrument and the forward contract are offsetting positions with respect to the same personal property and constitute a straddle. See section 1092(c)(1), (c)(3)(A)(i). When issued, the debt instrument is a position in personal property that is part of a straddle. See § 1.1092(d)-1(d). Consequently, D 's interest payments are interest and carrying charges properly allocable to personal property that is part of a straddle and must be allocated to the capital account for the forward contract for the delivery of x barrels of fuel oil to E . See §§ 1.263(g)-3(b)(1), (b)(3), (c)(3), and (d)(1) and -4(a)(1)(iii). Example 4 . Financial instrument issued to carry personal property that is part of a straddle. (i) Facts. The facts are the same as for Example 3 except that D also enters into a two-year interest rate swap under which D receives LIBOR times a notional principal amount equal to $ z and pays 7% times $ z . (ii) Analysis. Because of the relationship between the two-year debt instrument issued by D and the interest rate swap, the interest rate swap is a financial instrument that carries personal property that is part of a straddle. See § 1.263(g)-3(d)(4). Net payments made by D under the interest rate swap are chargeable to the capital account for the forward contract for the delivery of x barrels of fuel oil to E . Similarly, net payments received by D under the interest rate swap are allowable offsets. See § 1.263(g)-3(e)(5). Example 5 . Contingent payment debt instrument with embedded short position. (i) Facts. On January 1, 1998, G purchases 100,000 shares of the common stock of XYZ corporation (which is publicly traded). On January 1, 2002, the 100,000 shares of XYZ corporation common stock were worth $ x per share. On that date, G issued a contingent payment debt instrument for $100,000 x . The terms of the debt instrument provided that the holder would receive an annual payment of $2,000 x on December 31 of each year up to and including the maturity date of December 31, 2007. On the maturity date, the holders would also receive a payment of $100,000 x plus an additional amount, if the price of an XYZ share exceeded $1.2 x on such date, equal to 100,000 times three-quarters of the amount of such excess per share. Thus, G 's aggregate payments on the debt instrument varied directly with the increase in value in the XYZ shares. (ii) Analysis. The debt instrument is a position in XYZ stock. See § 1.1092(d)-1(d). The XYZ stock is personal property within the meaning of section 1092(d)(3)(B) because the debt instrument is a position with respect to substantially similar or related property (other than stock) within the meaning of section 1092(d)(3)(B)(i)(II). See § 1.1092(d)-2(c). The debt instrument and the XYZ shares are offsetting positions with respect to the same personal property and constitute a straddle. See sections 1092(c)(1), (c)(3)(A)(i). Consequently, G 's interest payments are interest and carrying charges properly allocable to personal property that is part of a straddle, see §§ 1.263(g)-3(b)(1), (b)(3), (c)(3), and (d)(1), and must be allocated to the capital account for the XYZ common stock, see § 1.263(g)-4(a)(1)(iii) and (a)(3). Example 6. Straddle including partnership interest. (i) Facts. H borrows money from I to purchase 100 ounces of gold at a cost of $ u. H transfers the 100 ounces of gold and $ v to a newly created trust that issues multiple classes of trust certificates and is treated as a partnership for tax purposes. In return, H receives two trust certificates. One certificate entitles the holder to a payment on termination of the trust at the end of four years equal to the value of the 100 ounces of gold up to a maximum value of $( u + w ). The other certificate entitles the holder to a payment equal to the amount by which the value of 100 ounces of gold exceeds $( u + w ) on termination of the trust. H sells the second certificate and keeps the first certificate. H also enters into a forward contract to sell 100 ounces of gold for $1.12 u per ounce on a date two years after creation of the trust. The trust uses part of the $ v and similar cash contributions from other investors to pay costs of storing the gold held by the trust and allocates H 's share of the expenses to H. (ii) Analysis. The trust certificate retained by H and the forward contract entered into by H are personal property for the purposes of section 263(g). See § 1.263(g)-2(a). They are also offsetting positions and constitute a straddle. Section 1092(c)(1). The borrowing from I is an indebtedness incurred to purchase personal property that is part of a straddle. See §§ 1.263(g)-3(b)(1) and (c)(1). Similarly, the gold storage expenses are expenses incurred due to the taxpayer's holding personal property that is part of a straddle. See § 1.263(g)-3(b)(2). Therefore both the interest on the borrowing and the gold storage expenses must be allocated to the capital account for the partnership interest represented by the retained trust certificate. See § 1.263(g)-4(a)(1)(i) and (a)(2). Example 7. Equity Swap. (i) Facts. On January 1, 1998, J purchases 100,000 shares of the common stock of XYZ corporation (which is publicly traded). On December 31, 2001, the 100,000 shares of XYZ corporation common stock were worth $ x per share. On that date, J entered into a NPC with K. The terms of the NPC provided that K would receive an annual payment on December 31 of each year equal to 100,000 times any appreciation in the value of a share of XYZ corporation stock above its price at the end of trading on December 31 of the preceding year and 100,000 times the dividends paid during the year on each share of XYZ corporation stock. In return, on December 31 of each year, J would receive an amount equal to LIBOR times the value of 100,000 XYZ shares at the end of trading on December 31 of the preceding year plus 100,000 times the amount of any decrease in the value of a share of XYZ corporation stock below its price at the end of trading on December 31 of the preceding year. Payments between J and K would be netted and continue up to and including the maturity date of the NPC on December 31, 2008. Thus, J 's aggregate payments on the NPC varied directly with the increase in value in the XYZ shares. (ii) Analysis. The NPC is a position in XYZ stock. See § 1.1092(d)-2(c). The XYZ stock is personal property within the meaning of section 1092(d)(3)(B) because the NPC is a position with respect to substantially similar or related property (other than stock) within the meaning of section 1092(b)(3)(B)(i)(II). See § 1.1092(d)-2(a)(1)(ii). The NPC and the XYZ shares are offsetting positions with respect to the same personal property and constitute a straddle. See sections 1092(c)(1), (c)(3)(A)(i). Consequently, J 's payments are interest and carrying charges properly allocable to personal property that is part of a straddle. See §§ 1.263(g)-3(b)(3) and (d)(1). Therefore, they should be allocated to the personal property that is part of the straddle in the manner that is most appropriate under all the facts and circumstances. In this case, because these payments are incurred to carry the XYZ shares, they should be allocated to the capital account for the XYZ common stock. See § 1.263(g)-4(a)(3).