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Holly at the time the investors' loss positions were locked in.
Mere bookkeeping entries were made to reflect the so-called
cancellation fees.
Just prior to the end of each year, the individual partners
of Holly obtained bank loans and made contributions to their
partnership capital accounts in Holly in amounts sufficient to
pay the cancellation fees owed by Holly. Holly then used such
funds to pay the cancellation fees to AGS and treated the fees as
ordinary losses at the partnership level and passed through the
claimed ordinary losses to the individual partners.
Just after the first of each year, AGS paid to Holly an
amount essentially equivalent to the cancellation fees that Holly
had paid AGS at the end of the prior year -- reflecting the gains
that were locked in on the straddle transactions. Holly then
distributed these funds to the individual partners as a return of
capital, and the partners used these funds to repay their bank
loans approximately 1 to 2 weeks after having been loaned the
funds.
On its Federal income tax returns for the years in issue,
Holly treated losses arising from forward contracts closed by
offset as capital losses. Holly, however, reported losses
arising from forward contracts closed by “cancellation”
(regardless of whether or not replacement contracts were
purchased) as ordinary losses.
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