The taxpayer's basis in the units of nonfunctional currency or other property received in the transaction shall be the adjusted basis of the units of nonfunctional currency or other property transferred. See paragraph (b) of this section with respect to the timing of interest income or expense and the determination of exchange gain or loss thereon.
Example. X is a corporation on the accrual method of accounting with the U.S. dollar as its functional currency. On January 1, 1989, X acquires 1,500 British pounds ([POUND]) for $2,250 ([POUND]1 = $1.50). On January 3, 1989, when the spot rate is [POUND]1 = $1.49, X deposits the [POUND]1,500 with a British financial institution in a non-interest bearing demand account. On February 1, 1989, when the spot rate is [POUND]1 = $1.45, X withdraws the [POUND]1,500. On February 5, 1989, when the spot rate is [POUND]1 = $1.42, X purchases inventory in the amount of [POUND]1,500. Pursuant to paragraph (a)(1)(iii) of this section, no exchange loss is realized until February 5, 1989, when X disposes of the [POUND]1,500 for inventory. At that time, X realizes exchange loss in the amount of $120 computed under paragraph (a)(2) of this section. The loss is not an adjustment to the cost of the inventory.
Example. G is a U.S. corporation with the U.S. dollar as its functional currency. On January 1, 1989, G enters into a contract to purchase a paper manufacturing machine for 10,000,000 British pounds ([POUND]) for delivery on January 1, 1991. On January 1, 1991, when G exchanges [POUND]10,000,000 (which G purchased for $12,000,000) for the machine, the fair market value of the machine is [POUND]17,000,000. On January 1, 1991, the spot exchange rate is [POUND]1 = $1.50. Under paragraph (a)(2)(ii)(B) of this section, the transaction is treated as an exchange of [POUND]10,000,000 for $15,000,000 and the purchase of the machine for $15,000,000. Accordingly, in computing G's exchange gain of $3,000,000 on the disposition of the [POUND]10,000,000, the amount realized is $15,000,000. G's basis in the machine is $15,000,000. No gain is recognized on the bargain purchase of the machine.
Example.
Date | Swiss francs deposited | Interest received | U.S. dollar basis | Aggregate U.S. dollar basis |
1/01/89 | 1000 Sf | $500 | $500 | |
3/31/89 | 50 Sf | 25 | 525 | |
6/30/89 | 50 Sf | 24 | 549 | |
9/30/89 | 50 Sf | 25 | 574 | |
12/31/89 | 50 Sf | 26 | 600 |
Example. On November 1, 1989 (the trade date), X, a calendar year cash basis U.S. individual, purchases stock for [POUND]100 for settlement on November 5, 1989. On November 1, 1989, the spot value of the [POUND]100 is $140. On November 5, 1989, X purchases [POUND]100 for $141 which X uses to pay for the stock. X's basis in the stock is $141. On December 30, 1990 (the trade date), X sells the stock for [POUND]110 for settlement on January 5, 1991. On December 30, 1990, the spot value of [POUND]110 is $165. On January 5, 1991, X transfers the stock and receives [POUND]110 which, translated at the spot rate, equal $166. Under section 453(k), the stock is considered disposed of on December 30, 1990. The amount realized with respect to such disposition is the value of the [POUND]110 on January 5, 1991 ($166). Accordingly, X's gain realized on December 30, 1990, from the disposition of the stock is $25 ($166 amount realized less $141 basis). X's basis in the [POUND]110 received from the sale of the stock is $166.
Date | Spot rate (pounds to dollars) |
Jan. 1, 1992 | [POUND]1 = $1.30 |
Dec. 31, 1992 | [POUND]1 = $1.35 |
Dec. 31, 1993 | [POUND]1 = $1.40 |
Dec. 31, 1994 | [POUND]1 = $1.45 |
Accrual period | Average rate (pounds to dollars) |
1992 | [POUND]1 = $1.32 |
1993 | [POUND]1 = $1.37 |
1994 | [POUND]1 = $1.42 |
Year | Spot value interest received | Accrued interest @ average rate | Exch. gain |
1992 | $1,350 | $1,320 | $30 |
1993 | 1,400 | 1,370 | 30 |
1994 | 1,450 | 1,420 | 30 |
Total | $90 |
Date | Spot rate1 |
Jan. 1, 1989 | 1 = $1.50 |
Dec. 31, 1989 | 1 = 1.60 |
Dec. 31, 1990 | 1 = 1.70 |
1 Pounds to dollars.
Assume that the basis of the [POUND]1,200 paid as interest by X on December 31, 1989, is $2,000, the basis of the [POUND]1,200 paid as interest by X on December 31, 1990, is $2,020 and the basis of the [POUND]10,000 principal paid by X on December 31, 1990, is $16,000.
Date | Spot rate1 |
Jan. 31, 1992 | [POUND]1 = $1.50 |
July 31, 1992 | [POUND]1 = 1.55 |
Dec. 31, 1992 | [POUND]1 = 1.60 |
Jan. 31, 1993 | [POUND]1 = 1.61 |
1 Pounds to dollars.
Table 1
Year (Dec. 31) | Periodic interest payments in pounds for the accrual period | Original issue discount in pounds for the accrual period | Issue price or adjusted issue price in pounds | Assumed spot rate on Dec. 31 (pounds to dollars) | Assumed average rate for accrual period (pounds to dollars) | Periodic interest payments in pounds multiplied by spot rate on the date of payment (column 2 times column 5) | Original issue discount in pounds multiplied by the average rate for the accrual period (column 3 times column 6) | Total interest income in dollars (column 7 plus column 8) | Adjusted issue price in dollars |
1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 |
Issue Date: | |||||||||
65.88 | 1 = $1.20 | $79.06 | |||||||
1992 | 1 | 5.59 | 71.47 | 1 = 1.30 | 1 = $1.25 | $1.30 | $6.99 | $8.29 | 86.05 |
1993 | 1 | 6.15 | 77.62 | 1 = 1.40 | 1 = 1.35 | 1.40 | 8.30 | 9.70 | 94.35 |
1994 | 1 | 6.76 | 84.38 | 1 = 1.50 | 1 = 1.45 | 1.50 | 9.80 | 11.30 | 104.15 |
1995 | 1 | 7.44 | 91.82 | 1 = 1.60 | 1 = 1.55 | 1.60 | 11.53 | 13.13 | 115.68 |
1996 | 1 | 8.18 | 100.00 | 1 = 1.70 | 1 = 1.65 | 1.70 | 13.50 | 15.20 | 129.18 |
Table 2
Year | OID accrued in pounds for each accrual period | Assumed spot rate on date payment received (pounds to dollars) | Interest received times spot rate on the date received (col. 2 times col. 3) | Assumed average rate for accrual period (pounds to dollars) | IOD in pounds times the average rate for the accrual period (col. 2 times col. 5) | Exchange gain or loss (col. 4 less col. 6) |
1 | 2 | 3 | 4 | 5 | 6 | 7 |
1992 | 5.59 | 1 = $1.70 | $9.50 | 1 = $1.25 | $6.99 | $2.51 |
1993 | 6.15 | 1 = 1.70 | 10.46 | 1 = 1.35 | 8.30 | 2.16 |
1994 | 6.76 | 1 = 1.70 | 11.49 | 1 = 1.45 | 9.80 | 1.69 |
1995 | 7.44 | 1 = 1.70 | 12.65 | 1 = 1.55 | 11.53 | 1.12 |
1996 | 8.18 | 1 = 1.70 | 13.90 | 1 = 1.65 | 13.50 | .40 |
Total | $7.88 |
Year (Dec. 31) | Original issue discount in pounds multiplied by the spot rate on last day of accrual period (Dec. 31) | Total interest income in dollars (column 7 plus column 8) | Adjusted issue price in dollars |
1 | 8 | 9 | 10 |
$79.06 | |||
1992 | $7.27 | $8.57 | 87.63 |
1993 | 8.61 | 10.01 | 97.64 |
1994 | 10.14 | 11.64 | 109.28 |
1995 | 11.90 | 13.50 | 122.78 |
1996 | 13.91 | 15.61 | 138.39 |
Year | Spot rate on last day of accrual period | OID in pounds times the spot rate on the last day of the accrual period (col 2 times col. 3) | Exchange gain or loss (col. 4 less col. 6) |
1 | 5 | 6 | 7 |
1992 | $1.30 | $7.27 | $2.23 |
1993 | 1.40 | 8.61 | 1.85 |
1994 | 1.50 | 10.14 | 1.35 |
1995 | 1.60 | 11.90 | 0.75 |
1996 | 1.70 | 13.90 | 0.00 |
6.18 |
Date | Principal | Interest |
Dec. 31, 1989 | [POUND]47.62 | [POUND]10.00 |
Dec. 12, 1990 | [POUND]52.38 | [POUND]5.24 |
Date | Spot rate [POUND]1= | Average rate for year ending |
Jan. 1, 1989 | $1.30 | |
Dec. 31, 1989 | 1.40 | 1.35 |
Dec. 31, 1990 | 1.50 | 1.45 |
Example.
Year ending 12/31 | Bond premium amortized | Unamortized premium plus principal | Interest |
[POUND]107.99 | |||
1989 | [POUND]1.36 | [POUND]106.63 | [POUND]8.64 |
1990 | [POUND]1.47 | [POUND]105.16 | [POUND]8.53 |
1991 | [POUND]1.59 | [POUND]103.57 | [POUND]8.41 |
1992 | [POUND]1.71 | [POUND]101.86 | [POUND]8.29 |
1993 | [POUND]1.85 | [POUND]100.00 | [POUND]8.15 |
Example.
Example. When the Turkish lira (TL) is a hyperinflationary currency, A, a U.S. corporation with the U.S. dollar as its functional currency, makes a 5 year, 100,000 TL-denominated loan to B, an unrelated corporation, at a 10% interest rate when 1,000 TL equals $1. Under the terms of the debt instrument, B must pay interest annually to A in amount of Turkish lira that is equal to $100. Also under the terms of the debt instrument, B must pay A upon maturity of the debt instrument an amount of Turkish lira that is equal to $1,000. Although the principal and interest are payable in a hyperinflationary currency, the debt instrument is a synthetic dollar debt instrument and is not subject to paragraph (b)(15)(i) of this section.
A currency swap contract may also require an exchange of the swap principal amount upon commencement of the agreement.
Except as provided in paragraph (e)(2)(v) of this section, the hypothetical issue price of such hypothetical borrowing and loan shall be the swap principal amount. The hypothetical stated redemption price at maturity is the total of all payments (excluding any exchange of the swap principal amount at the inception of the contract) provided under the hypothetical borrowing or loan other than periodic interest payments under the principles of section 1273. For purposes of determining economic accrual under the currency swap, the number of hypothetical interest compounding periods of such hypothetical borrowing and loan shall be determined pursuant to a semiannual compounding convention unless the currency swap contract indicates otherwise. For purposes of determining the timing and amount of the periodic interim payments, the principles regarding the amortization of interest (see generally, sections 1272 through 1275 and 163(e)) shall apply to the hypothetical interest expense and income of such hypothetical borrowing and loan. However, such principles shall not apply to determine the time when principal is deemed to be paid on the hypothetical borrowing and loan. See paragraph (d)(2)(iii) of this section and Example 2 of paragraph (d)(5) of this section with respect to the time when principal is deemed to be paid. With respect to the translation and computation of exchange gain or loss on any hypothetical interest income or expense, see § 1.988-2(b) . The amount treated as exchange gain or loss by the taxpayer with respect to the periodic interim payments for the taxable year shall be the amount of hypothetical interest income and exchange gain or loss attributable to such interest income from the hypothetical borrowing and loan for such year less the amount of hypothetical interest expense and exchange gain or loss attributable to the interest expense from such hypothetical borrowing and loan for such year.
Any amount taken into account pursuant to this paragraph (e)(3)(ii) shall be treated as exchange gain or loss.
Assume that the spot rate is [POUND]1 = $1.50 on January 1, 1989, [POUND]1 = $1.40 on December 31, 1989, and [POUND]1 = $1.30 on December 31, 1990. Assume further that the average rate for 1989 is [POUND]1 = $1.45 and for 1990 is [POUND]1 = $1.35.
Date | C pays | J pays |
December 31, 1989 | $15.00 | [POUND]12.00 |
December 31, 1990 | 41.04 | 12.00 |
December 31, 1991 | 0.00 | 12.00 |
December 31, 1992 | 150.00 | 112.00 |
Amount taken into account | Adjusted issue price | |
December 31, 1989 | $15.00 | 150.00 |
December 31, 1990 | $15.00 | 123.96 |
December 31, 1991 | $12.40 | 136.36 |
December 31, 1992 | $13.64 |
Example.
Date | Dollar | LC |
1/1/90 | (100) | 100 |
12/31/90 | 0 | 0 |
12/31/91 | 0 | 0 |
12/31/92 | 133 | (109.3) |
26 C.F.R. §1.988-2