[Federal Register Volume 60, Number 53 (Monday, March 20, 1995)]
[Rules and Regulations]
[Pages 14636-14641]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-6693]



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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8590]
RIN 1545-AR10


Dividends Received Deduction Holding Period Reduced for Periods 
Where Risk of Loss Diminished

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the 
reduction in the holding period of stock where a taxpayer has 
diminished its risk of loss by holding one or more other positions with 
respect to substantially similar or [[Page 14637]] related property. In 
addition, this document contains final regulations relating to tax 
straddles involving stock and substantially similar or related 
property. The regulations, in response to specific congressional 
direction, provide guidance to taxpayers with respect to the 
availability of the dividends received deduction and the application of 
the rules relating to tax straddles.

DATES: These regulations are effective March 20, 1995.
    For dates of applicability of these regulations, see Sec. 1.246-
5(e) and Sec. 1.1092(d)-2(b).

FOR FURTHER INFORMATION CONTACT: Nicholas G. Bogos or Thomas M. Preston 
of the Office of the Assistant Chief Counsel, Financial Institutions 
and Products, (202) 622-3920 or 622-3940, respectively (not a toll-free 
call).

SUPPLEMENTARY INFORMATION:

Background

    On May 27, 1993, proposed regulations Sec. 1.246-5 and 
Sec. 1.1092(d)-2 under sections 246(c)(4)(C) and 1092(d)(3)(B) 
respectively were published in the Federal Register (58 FR 45080). A 
public hearing was held on September 28, 1993. After IRS and Treasury 
consideration of the public comments on the proposed regulations, the 
regulations are adopted as revised by this Treasury decision.

Explanation of Provisions

    The final regulations retain, with only minor modifications, the 
definitions of substantially similar or related property and diminished 
risk of loss that are contained in the proposed regulations. Property 
is 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 factor or factors 
(such as interest rates, commodity prices, or foreign-currency exchange 
rates), and changes in the fair market value of the stock are 
reasonably expected to approximate, directly or inversely, changes in 
the fair market value of the property. A taxpayer has diminished its 
risk of loss if changes in the fair market values of the stock and a 
position with respect to substantially similar or related property are 
reasonably expected to vary inversely.
    Several commentators argued that the definition of substantially 
similar or related property improperly focuses on the economic 
relationship between the stock and the other property held by the 
taxpayer. They argued that this approach fails to give independent 
substance to the two parts of the statutory test, namely, (a) risk 
reduction, and (b) holding positions in substantially similar or 
related property.
    The IRS and Treasury believe that the rule, as finalized, gives 
appropriate weight both to risk reduction and to whether the taxpayer 
holds a position in substantially similar or related property. The only 
way to determine when properties are substantially similar or related 
for purposes of section 246(c)(4)(C) is by taking into account the 
economic characteristics of the properties. A definition that did not 
look to the economic relationships of properties would give undue 
deference to labels and would not serve the purposes of section 
246(c)(4)(C).
    Several commentators suggested that the regulations should provide 
a safe harbor under which taxpayers could establish that properties are 
not substantially similar or related by demonstrating a sufficiently 
low mathematical correlation between the changes in the price of stock 
and changes in the price of the other property. The final regulations 
do not include the suggested safe harbor because the IRS and Treasury 
have not identified a simple, workable safe harbor that would be 
appropriate in all cases and that the IRS could effectively administer. 
The IRS and Treasury continue to welcome suggestions for a safe harbor.
    Although the final regulations retain the definition of 
substantially similar or related property, Example 6 of the proposed 
regulations has been eliminated. This example, which was widely 
criticized by commentators, concludes that a nonparticipating, fixed-
term, preferred stock is substantially similar to Treasury securities 
because both types of property primarily reflect the performance of the 
same economic factor--interest rates--and changes in the value of the 
stock will approximate changes in the value of the Treasury securities. 
The commentators argued that, although hedging preferred stock with 
Treasury securities may provide protection against the impact of 
substantial movements in overall interest rates, the value of preferred 
stock can also be significantly affected by other economic factors, 
such as the issuer's credit risk. Thus, they argued, the stock and the 
Treasury securities do not primarily reflect the performance of the 
same economic factor, and changes in their fair market values are not 
reasonably expected to approximate each other.
    Whether offsetting positions constitute substantially similar or 
related property is determined based on the facts and circumstances of 
each case. Commentators demonstrated that, in many cases, changes in 
the price of Treasury securities would not approximate changes in the 
price of a preferred stock. Therefore, Example 6 of the proposed 
regulations has been eliminated. Whether Treasury securities or other 
interest-sensitive property is substantially similar or related to a 
particular preferred stock must be decided on a case-by-case basis. The 
elimination of Example 6 does not preclude a finding that such property 
or securities are substantially similar or related to preferred stock 
in appropriate cases.
    Examples 3 and 8 of the proposed regulations were eliminated 
because, after further consideration, the IRS and Treasury decided the 
regulations were sufficiently clear without the examples.
    The proposed regulations state that, notwithstanding the general 
rule, two portfolios of stocks are substantially similar or related if 
changes in their fair market values are reasonably expected to 
approximate each other. Commentators suggested that this rule did not 
give effect to the statement in the legislative history that the 
substantially similar or related standard is not satisfied merely 
because the taxpayer is an investor with diversified holdings and 
acquires a regulated futures contract or an option on a stock index to 
hedge general market risks. Commentators suggested that, even if 
changes in the values of two portfolios approximate each other, the 
substantially similar or related standard should be met only if the 
portfolios substantially overlap.
    The final regulations adopt this suggestion subject to an anti-
abuse rule. Under the final regulations, a position that reflects the 
value of a portfolio is not treated as substantially similar or related 
to the taxpayer's stock holdings unless the stock holdings and the 
portfolio substantially overlap. For this purpose, a taxpayer's stock 
holdings substantially overlap with a portfolio if the taxpayer holds 
70 percent, by value, of the stocks in the portfolio (that is, the 
taxpayer holds 70 percent of the capitalization of the portfolio). A 
mechanical rule is provided for determining substantial overlap. The 
final regulations also define a portfolio as 20 or more stocks and 
provide that positions that reflect the value of more than one stock 
but less than 20 are treated as positions in each of the underlying 
stocks.
    If the anti-abuse rule applies, a position that reflects the value 
of two or more stocks (including a portfolio) is treated as 
substantially similar or related property even if those stocks and 
[[Page 14638]] the taxpayer's stock holdings do not substantially 
overlap. The anti-abuse rule applies when the following two conditions 
are met. First, changes in the value of the position or the stocks 
reflected in a position are reasonably expected to virtually track 
(directly or inversely) changes in the value of the taxpayer's stock 
holdings or any portion of the taxpayer's stock holdings and other 
positions of the taxpayer; and, second, the position is acquired or 
held as part of a plan a principal purpose of which is to obtain tax 
savings (including by deferring tax) that are significantly in excess 
of the expected pre-tax economic profits from the plan. Of course, 
common law doctrines and statutory authorities, such as substance over 
form, the sham transaction doctrine, and the clear reflection of income 
requirement, continue to apply notwithstanding any provision of these 
regulations. See, e.g., Sheldon v. Commissioner, 94 T.C. 738 (1990).
    The final regulations generally retain the other provisions of the 
proposed regulations with the following modifications. The final 
regulations define a position, for purposes of section 246(c)(4)(C), as 
an interest (including a futures or forward contract or an option) in 
property or any contractual right to a payment, whether or not 
severable from stock or other property. Thus, for purposes of section 
246(c)(4)(C), stock coupled with an option to sell the stock will not 
be treated as a single instrument (regardless of whether the option 
trades separately from the stock). A position does not, however, 
include traditional equity rights to demand payment from the issuer, 
such as rights traditionally provided by mandatorily redeemable 
preferred stock. The definition of position does not apply for purposes 
of section 1092, which includes its own definition of position in 
section 1092(d)(2).
    The final regulations make clear that certain convertible 
instruments are substantially similar or related property. Thus, the 
holding period of stock may be tolled if the taxpayer holds an 
instrument that is convertible into property that is substantially 
similar or related to the taxpayer's stock. The situations identified 
in the final regulations are taken directly from the legislative 
history underlying the statutory provision. See H.R. Conf. Rep. No. 
861, 98th Cong., 2d Sess. 818 (1984).
    For hedges of positions other than stock, the final regulations 
retain the rule in the proposed regulations that hedges of one position 
are not treated as hedges of another position (including stock). The 
final regulations clarify that relationships established in the 
taxpayer's books and records at the time the positions are entered into 
are given substantial deference. In addition, the final regulations 
provide that a taxpayer that diminishes its risk of loss in stock by 
holding a position in substantially similar or related property is 
treated as diminishing the risk of loss on the shares with the shortest 
holding period.
    The final regulations retain the rule in the proposed regulations 
that a guarantee, surety agreement, or similar arrangement is treated 
as substantially similar or related property if it substantially 
offsets decreases in the fair market value of the stock. The IRS and 
Treasury caution that these arrangements or similar rights (even if 
they do not substantially offset decreases in the fair market value of 
the stock) may also be treated as options (whether settled in cash or 
property) to sell the stock for purposes of section 246(c)(4)(A). For 
example, if an instrument is debt for state law purposes but stock for 
federal income tax purposes, creditor's rights on the instrument are 
treated as options to sell. See Rev. Rul. 94-28, 1994-1 C.B. 86.
    The final regulations clarify the treatment of notional principal 
contracts as substantially similar or related property. Under the final 
regulations, an analysis of whether a notional principal contract is a 
position in substantially similar or related property that diminishes 
risk must take into account the gross payments due under the contract 
even if payments under the contract are netted for other purposes. 
Thus, a taxpayer cannot look solely to the net payments that it expects 
to receive and argue that, because fluctuations in the value of the 
swap may not approximate changes in the value of the stock, the swap is 
not substantially similar or related to the stock, and does not 
diminish the taxpayer's risk of loss.
    The final regulations defining substantially similar or related 
property under section 1092 of the Code are found in new 
Sec. 1.1092(d)-2. The regulations provide that the definition of the 
term substantially similar or related property in Sec. 1.246-5 is 
generally applicable for purposes of section 1092(d)(3)(B).

Effective Dates

    The regulations contained in this Treasury decision generally are 
effective with respect to dividends received, and to positions 
established, on or after March 17, 1995 with respect to stock acquired 
after July 18, 1984. However, the regulations apply to dividends 
received by a taxpayer on stock acquired after July 18, 1984, and to 
positions established after March 1, 1984, with respect to certain 
specific transactions listed in the legislative history.

Special Analysis

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in EO 12866. Therefore, a 
regulatory assessment is not required. It has also been determined that 
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) 
and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to 
these regulations, and, therefore, a Regulatory Flexibility Analysis is 
not required. Pursuant to section 7805(f) of the Internal Revenue Code, 
the notice of proposed rulemaking preceding these regulations was 
submitted to the Small Business Administration for comment on their 
impact on small business.

Drafting Information

    The principal authors of these regulations are Nicholas G. Bogos 
and Thomas M. Preston, both of the Office of Assistant Chief Counsel 
(Financial Institutions and Products). However, other personnel from 
the IRS and Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended to read as follows:

PART 1--INCOME TAXES
    Paragraph 1. The authority citation for part 1 is amended by adding 
entries in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * *.

    Section 1.246-5 also issued under 26 U.S.C. 246(c) and 7701(f). 
* * *
    Section 1.1092(d)-2 also issued under 26 U.S.C. 1092(d)(3)(B). * 
* *

    Par. 2. Section 1.246-5 is added to read as follows:


Sec. 1.246-5  Reduction of holding periods in certain situations.

    (a) In general. Under section 246(c)(4)(C), the holding period of 
stock for purposes of the dividends received deduction is appropriately 
reduced for any period in which a taxpayer has diminished its risk of 
loss by holding one or more other positions with respect to 
substantially similar or related property. This section provides rules 
for applying section 246(c)(4)(C). [[Page 14639]] 
    (b) Definitions--(1) Substantially similar or related property. The 
term substantially similar or related property is applied according to 
the facts and circumstances in each case. In general, property is 
substantially similar or related to stock when--
    (i) The fair market values of the stock and the property primarily 
reflect the performance of--
    (A) A single firm or enterprise;
    (B) The same industry or industries; or
    (C) The same economic factor or factors such as (but not limited 
to) interest rates, commodity prices, or foreign-currency exchange 
rates; and
    (ii) Changes in the fair market value of the stock are reasonably 
expected to approximate, directly or inversely, changes in the fair 
market value of the property, a fraction of the fair market value of 
the property, or a multiple of the fair market value of the property.
    (2) Diminished risk of loss. A taxpayer has diminished its risk of 
loss on its stock by holding positions with respect to substantially 
similar or related property if changes in the fair market values of the 
stock and the positions are reasonably expected to vary inversely.
    (3) Position. For purposes of this section, a position with respect 
to property is an interest (including a futures or forward contract or 
an option) in property or any contractual right to a payment, whether 
or not severable from stock or other property. A position does not 
include traditional equity rights to demand payment from the issuer, 
such as the rights traditionally provided by mandatorily redeemable 
preferred stock.
    (4) Reasonable expectations. For purposes of paragraphs (b)(1)(i), 
(b)(2), or (c)(1)(vi) of this section, reasonable expectations are the 
expectations of a reasonable person, based on all the facts and 
circumstances at the later of the time the stock is acquired or the 
positions are entered into. Reasonable expectations include all 
explicit or implicit representations made with respect to the marketing 
or sale of the position.
    (c) Special rules--(1) Positions in more than one stock--(i) In 
general. This paragraph (c)(1) provides rules for the treatment of 
positions that reflect the value of more than one stock. In general, 
positions that reflect the value of a portfolio of stocks are treated 
under the rules of paragraphs (c)(1) (ii) through (iv) of this section, 
and positions that reflect the value of more than one stock but less 
than a portfolio are treated under the rules of paragraph (c)(1)(v) of 
this section. A portfolio for this purpose is any group of stocks of 20 
or more unrelated issuers. Paragraph (c)(1)(vi) of this section 
provides an anti-abuse rule.
    (ii) Portfolios. Notwithstanding paragraph (b)(1) of this section, 
a position reflecting the value of a portfolio of stocks is 
substantially similar or related to the stocks held by the taxpayer 
only if the position and the taxpayer's holdings substantially overlap 
as of the most recent testing date. A position may be substantially 
similar or related to a taxpayer's entire stock holdings or a portion 
of a taxpayer's stock holdings.
    (iii) Determining substantial overlap. This paragraph (c)(1)(iii) 
provides rules for determining whether a position and a taxpayer's 
stock holdings or a portion of a taxpayer's stock holdings 
substantially overlap. Paragraphs (c)(1)(iii) (A) through (C) of this 
section determine whether there is substantial overlap as of any 
testing date.
    (A) Step One. Construct a subportfolio (the Subportfolio) that 
consists of stock in an amount equal to the lesser of the fair market 
value of each stock represented in the position and the fair market 
value of the stock in the taxpayer's stock holdings. (The Subportfolio 
may contain fewer than 20 stocks.)
    (B) Step Two. If the fair market value of the Subportfolio is equal 
to or greater than 70 percent of the fair market value of the stocks 
represented in the position, the position and the Subportfolio 
substantially overlap.
    (C) Step Three. If the position does not substantially overlap with 
the Subportfolio, repeat Steps One and Two (paragraphs (c)(1)(iii)(A) 
and (B) of this section) reducing the size of the position. The largest 
percentage of the position that results in a substantial overlap is 
substantially similar or related to the Subportfolio determined with 
respect to that percentage of the position.
    (iv) Testing date. A testing date is any day on which the taxpayer 
purchases or sells any stock if the fair market value of the stock or 
the fair market value of substantially similar or related property is 
reflected in the position, any day on which the taxpayer changes the 
position, or any day on which the composition of the position changes.
    (v) Nonportfolio positions. A position that reflects the fair 
market value of more than one stock but not of a portfolio of stocks is 
treated as a separate position with respect to each of the stocks the 
value of which the position reflects.
    (vi) Anti-abuse rule. Notwithstanding paragraphs (c)(1)(i) through 
(v) of this section, a position that reflects the value of more than 
one stock is a position in substantially similar or related property to 
the appropriate portion of the taxpayer's stock holdings if--
    (A) Changes in the value of the position or the stocks reflected in 
the position are reasonably expected to virtually track (directly or 
inversely) changes in the value of the taxpayer's stock holdings, or 
any portion of the taxpayer's stock holdings and other positions of the 
taxpayer; and
    (B) The position is acquired or held as part of a plan a principal 
purpose of which is to obtain tax savings (including by deferring tax) 
the value of which is significantly in excess of the expected pre-tax 
economic profits from the plan.
    (2) Options--(i) Options that are significantly out of the money. 
For purposes of paragraph (b)(2) of this section, an option to sell 
that is significantly out of the money does not diminish the taxpayer's 
risk of loss on its stock unless the option is held as part of a 
strategy to substantially offset changes in the fair market value of 
the stock.
    (ii) Conversion rights. Notwithstanding paragraphs (b)(1) and (2) 
of this section, a taxpayer is treated as diminishing its risk of loss 
by holding substantially similar or related property if it engages in 
the following transactions or their substantial equivalents--
    (A) A short sale of common stock while holding convertible 
preferred stock of the same issuer and the price changes of the 
convertible preferred stock and the common stock are related;
    (B) A short sale of a convertible debenture while holding 
convertible preferred stock into which the debenture is convertible or 
common stock; or
    (C) A short sale of convertible preferred stock while holding 
common stock.
    (3) Stacking rule. If a taxpayer diminishes its risk of loss by 
holding a position in substantially similar or related property with 
respect to only a portion of the shares that the taxpayer holds in a 
particular stock, the holding period of those shares having the 
shortest holding period is reduced.
    (4) Guarantees, surety agreements, or similar arrangements. A 
taxpayer has diminished its risk of loss on stock by holding a position 
in substantially similar or related property if the taxpayer is the 
beneficiary of a guarantee, surety agreement, or similar arrangement 
and the guarantee, surety agreement, or similar arrangement provides 
for payments that will substantially offset decreases in the fair 
market value of the stock. [[Page 14640]] 
    (5) Hedges counted only once. A position established as a hedge of 
one outstanding position, transaction, or obligation of the taxpayer 
(other than stock) is not treated as diminishing the risk of loss with 
respect to any other position held by the taxpayer. In determining 
whether a position is established to hedge an outstanding position, 
transaction, or obligation of the taxpayer, substantial deference will 
be given to the relationships that are established in its books and 
records at the time the position is entered into.
    (6) Use of related persons or pass-through entities. Positions held 
by a party related to the taxpayer within the meaning of sections 
267(b) or 707(b)(1) are treated as positions held by the taxpayer if 
the positions are held with a view to avoiding the application of this 
section or Sec. 1.1092(d)-2. In addition, a taxpayer is treated as 
diminishing its risk of loss by holding substantially similar or 
related property if the taxpayer holds an interest in, or is the 
beneficiary of, a pass-through entity, intermediary, or other 
arrangement with a view to avoiding the application of this section or 
Sec. 1.1092(d)-2.
    (7) Notional principal contracts. For purposes of this section, 
rights and obligations under notional principal contracts are 
considered separately even though payments with regard to those rights 
and obligations are generally netted for other purposes. Therefore, if 
a taxpayer is treated under the preceding sentence as receiving 
payments under a notional principal contract when the fair market value 
of the taxpayer's stock declines, the taxpayer has diminished its risk 
of loss by holding a position in substantially similar or related 
property regardless of the netting of the payments under the contract 
for any other purposes.
    (d) Examples. The following examples illustrate the provisions of 
this section:
    Example 1. General application to common stock. Corporation A and 
Corporation B are both automobile manufacturers. The fair market values 
of Corporation A and Corporation B common stock primarily reflect the 
value of the same industry. Because Corporation A and Corporation B 
common stock are affected not only by the general level of growth in 
the industry but also by individual corporate management decisions and 
corporate capital structures, changes in the fair market value of 
Corporation A common stock are not reasonably expected to approximate 
changes in the fair market value of the Corporation B common stock. 
Under paragraph (b)(1) of this section, Corporation A common stock is 
not substantially similar or related to Corporation B common stock.
    Example 2. Common stock value primarily reflects commodity price. 
Corporation C and Corporation D both hold gold as their primary asset, 
and historically changes in the fair market value of Corporation C 
common stock approximated changes in the fair market value of 
Corporation D common stock. Corporation M purchased Corporation C 
common stock and sold short Corporation D common stock. Corporation C 
common stock is substantially similar or related to Corporation D 
common stock because their fair market values primarily reflect the 
performance of the same economic factor, the price of gold, and changes 
in the fair market value of Corporation C common stock are reasonably 
expected to approximate changes in the fair market value of Corporation 
D common stock. It was reasonably expected that changes in the fair 
market values of the Corporation C common stock and the short position 
in Corporation D common stock would vary inversely. Thus, Corporation M 
has diminished its risk of loss on its Corporation C common stock for 
purposes of section 246(c)(4)(C) and this section by holding a position 
in substantially similar or related property.
    Example 3. Portfolios of stocks--(i) Corporation Z holds a 
portfolio of stocks and acquires a short position on a publicly traded 
index through a regulated futures contract (RFC) that reflects the 
value of a portfolio of stocks as defined in paragraph (c)(1)(i) of 
this section. The index reflects the fair market value of stocks A 
through T. The values of stocks reflected in the index and the values 
of the same stocks in Corporation Z's holdings are as follows:

------------------------------------------------------------------------
                                            Z's                         
                 Stock                   holdings    RFC    Subportfolio
------------------------------------------------------------------------
A......................................      $300     $300        $300  
B......................................       300      300         300  
C......................................        --      300          --  
D......................................       400      500         400  
E......................................       300      500         300  
F......................................       300      500         300  
G......................................       500      600         500  
H......................................       300      300         300  
I......................................        --      300          --  
J......................................       400      450         400  
K......................................       200      500         200  
L......................................       200      400         200  
M......................................       200      500         200  
N......................................       100      200         100  
O......................................        --      200          --  
P......................................       200      200         200  
Q......................................       100      300         100  
R......................................       200      100         100  
S......................................       100      100         100  
T......................................       100      200         100  
                                        --------------------------------
      Totals...........................    $4,200   $6,750      $4,100  
------------------------------------------------------------------------

    (ii) The position is substantially similar or related to Z's stock 
holdings only if they substantially overlap. To determine whether they 
substantially overlap, Corporation Z must construct a Subportfolio of 
stocks with the lesser of the value of the stock as reflected in the 
RFC and its holdings. The Subportfolio is given in the rightmost column 
above. The value of the Subportfolio is 60.74 percent of the value of 
the stocks represented in the position ($4100<divide>$6750), so the 
position and the Subportfolio do not substantially overlap.
    (iii) To determine whether any portion of the position 
substantially overlaps with any portion of the Z's stock holdings, the 
values of the stocks in the RFC are reduced for purposes of the above 
steps. Eighty percent of the position and the corresponding 
subportfolio (consisting of stocks with a value of the lesser of the 
stocks represented in Z's holdings and in 80 percent of the RFC) 
substantially overlap, computed as follows:

------------------------------------------------------------------------
                                            Z's     80% of              
                 Stock                   holdings    RFC    Subportfolio
------------------------------------------------------------------------
A......................................      $300     $240        $240  
B......................................       300      240         240  
C......................................        --      240          --  
D......................................       400      400         400  
E......................................       300      400         300  
F......................................       300      400         300  
G......................................       500      480         480  
H......................................       300      240         240  
I......................................        --      240          --  
J......................................       400      360         360  
K......................................       200      400         200  
L......................................       200      320         200  
M......................................       200      400         200  
N......................................       100      160         100  
O......................................        --      160          --  
P......................................       200      160         160  
Q......................................       100      240         100  
R......................................       200       80          80  
S......................................       100       80          80  
T......................................       100      160         100  
                                        --------------------------------
      Totals...........................    $4,200   $5,400      $3,780  
------------------------------------------------------------------------

    (iv) Because $3,780 is 70 percent of $5,400, the Subportfolio 
substantially overlaps with 80 percent of the position. Under paragraph 
(c)(3) of this section, Z's stocks having the shortest holding period 
are treated as included in the Subportfolio. A larger portion of Z's 
stocks may be treated as substantially similar or related property 
under the [[Page 14641]] anti-abuse rule of paragraph (c)(1)(vi) of 
this section.

    Example 4. Hedges counted only once. January 1, 1996, Corporation X 
owns a $100 million portfolio of stocks all of which would 
substantially overlap with a $100 million regulated futures contract 
(RFC) on a commonly used index (the Index). On January 15, Corporation 
X enters into a $100 million short position in an RFC on the Index with 
a March delivery date and enters into a $75 million long position in an 
RFC on the Index for June delivery. Also on January 15, 1996, 
Corporation X indicates in its books and records that the long and 
short RFC positions are intended to offset one another. Under paragraph 
(c)(5) of this section, $75 million of the short position in the RFC is 
not treated as diminishing the risk of loss on the stock portfolio and 
instead is treated as a straddle or a hedging transaction, as 
appropriate, with respect to the $75 million long position in the RFC, 
under section 1092. The remaining $25 million short position is treated 
as diminishing the risk of loss on the portfolio by holding a position 
in substantially similar or related property. The rules of paragraph 
(c)(1) determine how much of the portfolio is subject to this rule and 
the rules of paragraph (c)(3) determine which shares have their holding 
periods tolled.

    (e) Effective date--(1) In general. The provisions of this section 
apply to dividends received on or after March 17, 1995, on stock 
acquired after July 18, 1984.

    (2) Special rule for dividends received on certain stock. 
Notwithstanding paragraph (e)(1) of this section, this section applies 
to any dividends received by a taxpayer on stock acquired after July 
18, 1984, if the taxpayer has diminished its risk of loss by holding 
substantially similar or related property involving the following types 
of transactions--

    (i) The short sale of common stock when holding convertible 
preferred stock of the same issuer and the price changes of the two 
stocks are related, or the short sale of a convertible debenture while 
holding convertible preferred stock into which the debenture is 
convertible (or common stock), or a short sale of convertible preferred 
stock while holding common stock; or

    (ii) The acquisition of a short position in a regulated futures 
contract on a stock index, or the acquisition of an option to sell the 
regulated futures contract or the stock index itself, or the grant of a 
deep-in-the-money option to buy the regulated futures contract or the 
stock index while holding the stock of an investment company whose 
principal holdings mimic the performance of the stocks included in the 
stock index; or alternatively, while holding a portfolio composed of 
stocks that mimic the performance of the stocks included in the stock 
index.

    Par. 3. Section 1.1092(d)-2 is added to read as follows:

Sec. 1.1092(d)-2  Personal property.

    (a) Special rules for stock. Under section 1092(d)(3)(B), personal 
property includes any stock that is part of a straddle, at least one of 
the offsetting positions of which is a position with respect to 
substantially similar or related property (other than stock). For 
purposes of this rule, the term substantially similar or related 
property is defined in Sec. 1.246-5 (other than Sec. 1.246-5(b)(3)). 
The rule in Sec. 1.246-5(c)(6) does not narrow the related party rule 
in section 1092(d)(4).

    (b) Effective date--(1) In general. This section applies to 
positions established on or after March 17, 1995.

    (2) Special rule for certain straddles. This section applies to 
positions established after March 1, 1984, if the taxpayer 
substantially diminished its risk of loss by holding substantially 
similar or related property involving the following types of 
transactions--

    (i) Holding offsetting positions consisting of stock and a 
convertible debenture of the same corporation where the price movements 
of the two positions are related; or

    (ii) Holding a short position in a stock index regulated futures 
contract (or alternatively an option on such a regulated futures 
contract or an option on the stock index) and stock in an investment 
company whose principal holdings mimic the performance of the stocks 
included in the stock index (or alternatively a portfolio of stocks 
whose performance mimics the performance of the stocks included in the 
stock index).

Margaret Milner Richardson,

Commissioner of Internal Revenue.

    Dated: March 3, 1995.

    Approved: Leslie Samuels, Assistant Secretary of the Treasury 
(Tax Policy).

[FR Doc. 95-6693 Filed 3-17-95; 8:45 am]
BILLING CODE 4830-01-U