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stock in a Brazilian company (with a fair market value of
$5,544,000). Consequently, the conversion produces a $7,033,136
loss. By utilizing the step transaction doctrine, petitioner
essentially ignores the conversion of the Brazilian debt into
cruzados and simultaneously the payment of the cruzados for the
stock.
Respondent, on the other hand, asserts that the step
transaction doctrine is inapplicable to petitioner's debt-equity
conversion. According to respondent, we should view the transaction
as an exchange of petitioner's blocked deposits for cruzados, which
were then used to purchase stock in a Brazilian company. Based on
this scenario, petitioner would recognize a loss on the exchange of
the debt for the cruzados only to the extent its adjusted basis in
the debt exceeded the fair market value of the cruzados. Respondent
contends that there was no excess (and thus, no loss) in this case:
petitioner exchanged blocked deposits with a $12,577,136 basis for
cruzados with a $12,577,136 fair market value. As an alternative
position, respondent claims that, assuming arguendo petitioner did
realize a loss, the loss did not exceed 10 percent of the
investment, or approximately $1.25 million.
A. The Brazilian Debt Crisis
In the late 1970's, Latin American countries borrowed heavily
abroad. As part of its response to higher world oil prices, the
Brazilian Government embarked on a major program of import-
substituting industrialization. This development strategy involved
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