The first contracts will be based on indices of HDDs and CDDs for certain United States population centers. It is expected that the CME contract will be based on cumulative monthly HDDs and CDDs. Contracts will provide for delivery in all consecutive calendar months. Once a company identifies a possible weather derivatives transaction, a key tax question is whether the transaction meets the tax definition of a hedge. This is because gains and losses from qualifying tax hedges receive favorable tax treatment, with gains and losses ordinary, not capital.
Ordinary losses are deductible against business income.
Capital losses can only be deducted to the extent the company has capital gains from other sources. If a transaction meets the tax hedge definition, the taxpayer, to obtain favorable tax hedge treatment, must then meet tax identification requirements. The remainder of this section looks at the tax qualifications and identification requirements for tax hedges. Hedges Defined A tax hedge is entered into in the normal course of the company's trade or business primarily to reduce a risk set out in the Treasury regulations. First, a company can reduce price changes or currency fluctuations with respect to ordinary property.