Senate Finance Committee Ranking Member Ron Wyden (D-OR) on May 18 released a discussion draft of legislation to overhaul the taxation of derivatives. With critical exceptions for multifamily real estate, the Modernization of Derivatives Tax Act of 2016 would require owners of certain derivatives to mark-to-market their value at the end of every year and then pay income taxes on gain as ordinary income.
Derivatives tied to real estate would be exempted under the proposal if the underlying contract requires physical delivery of the property. This exclusion means that a taxpayer who enters into an option to purchase or sell an apartment building does not have a taxable event at the end of a year, provided that if the taxpayer exercises the option, the contract mandates physical delivery of the property. Additionally, this exception includes contracts that enable the sale or purchase of physically delivered property.
The proposal is also not designed to ensnare businesses that hedge against business risk. Derivatives used to offset business risks, including those related to interest rates and currency fluctuations, are exempted from marking to market their value for tax purposes.
Importantly, this is Senator Wyden’s second attempt at overhauling discrete pieces of the tax code and follows a cost recovery discussion draft released in late April. Although neither plan is expected to move forward this year, they both could be dropped into tax reform legislation that may see action in 2017.
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