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The regulations under section 1221 also contain a provision
which governs the treatment of hedging transactions. Sec.
1.1221-2, Income Tax Regs. Under this provision, "the term
capital asset does not include property that is part of a hedging
transaction". Sec. 1.1221-2(a)(1), Income Tax Regs.
A hedging transaction is "a transaction that a taxpayer
enters into in the normal course of the taxpayer's trade or
business primarily * * * to reduce risk of price changes or
currency fluctuations with respect to ordinary property * * *
that is held or to be held by the taxpayer". Sec. 1.1221-
2(b)(1), Income Tax Regs. Property is "ordinary property" only
if a sale or exchange of the property by the taxpayer could not
produce capital gain or loss regardless of the taxpayer's holding
period when the sale or exchange occurs. Sec. 1.1221-2(c)(5)(i),
Income Tax Regs. The regulations under section 1.1221-2 are
intended to provide the only definition of a "hedging
transaction". Sec. 1.1221-2(a)(3), Income Tax Regs.
Under the regulations, whether or not a transaction reduces
the risk of price changes or currency fluctuations is determined
"based on all of the facts and circumstances" surrounding the
taxpayer's business and the transaction. Sec. 1.1221-2(c)(1)(i),
Income Tax Regs. In applying this concept, we look to case law
to determine whether a transaction reduces a taxpayer's risk.
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Last modified: May 25, 2011