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What must be done to obtain hedging treatment for US federal income tax purposes, and what is the benefit of obtaining hedging treatment?

Hedging Treatment US Federal Income
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Chris Haunschild
In order to obtain hedging treatment for US Federal income tax purposes, two primary requirements must be satisfied: (i) the transaction must manage risk, and (ii) the transaction must be properly identified within the meaning of the regulations
The general rule is that improperly identified hedges give rise to ordinary income (if profitable) and capital losses (if unprofitable). Thus, if there is a failure with respect to profitable hedges, the failure to identify might have no impact. The primary concern is with respect to the failure to identify loss hedges, which could result in the taxpayer having ordinary income on the underlying risk and a capital loss on the hedge itself. If such capital losses are not useable (i.e., the taxpayer has no capital gains), there would be a net tax exposure on the overall transactions that would not have occurred if the hedges had been properly identified.

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