Abusive Straddles
IRS Notice 2002-50 (Partnership Straddles)
IRS Notice 2002-65 (Pass-Through Entity Straddles)
IRS Notice 2003-54 (Common Trust Fund Straddles)

 

 

In IRS Notice 2002-50, the government announced that they had become aware of an abusive transaction aimed at generating deductions, through the use of a straddle, a tiered partnership structure, a transitory partner, and the absence of a Section 754 election to enable a taxpayer to claim a permanent non-economic loss. In IRS Notice 2002-65, the government announced that they had become aware of a variation on the approach undertaken with a S corporation. In IRS Notice 2003-54, the government announced that they had become aware of yet another variation of this approach using a grantor trust and common trust funds.

The IRS proposes to attack this particular transaction on a number of grounds. First, the IRS will claim that the partnership anti-abuse rules contained in Regs. Section 1.701-2(b) will generally act to disallow the deduction claimed by the taxpayer upon the termination of the loss leg of the straddle. See Regs. Sec. 1.701-2(d), Example 8 (disallowing duplication of a built-in loss deduction attributable to the absence of a Section 754 election). Second, the IRS may challenge the allowance of the loss deduction based on other statutory provisions as well as the step transaction, substance over form, business purpose, and economic substance judicial principles. Third, the IRS may rely on an aggregate theory of partnership taxation and claim that the disallowed loss realized on the sale of the LTP interest by UTP cannot be utilized to offset the gain realized by the taxpayer on the sale of its interest in LTP.

If you believe that you may have engaged in a transaction that is the same or substantially similar to the transaction described above, Federal law may require you to disclose your and other parties’ participation in any such “listed transaction” on IRS Form 8886. For more information about Federal law requirements, please contact us.