Thanks so much for all you do on this site. As a former attorney who hates misinformation (!!), not too long ago I posted what I am going to share here in response to someone else who had raised the very same issue about the paragraph quoted by the CPA from IRS publication 525 page 33 about capital gains treatment for personal foreign currency transactions.
It’s true that there is that one paragraph in that publication. The problem is that that paragraph does not define “personal transaction” and therefore becomes totally misleading for people who have bought foreign currency as an investment, because section 988 of the code defines “personal transaction” in a way that does not apply to us. And that little paragraph in publication 525 comes right out of section 988.
The definition of “Personal transaction” basically distinguishes between the traveler who happens to cash in excess currency from a trip and the person who buys foreign currency as an investment. According to section 988, when read in its entirety, the capital gains treatment is only for the person who did not purchase it as an investment, i.e., the traveler. As to the traveler types, it is considered as a “personal transaction,” under Section 988 which carves out a special exception for such transactions, and they are taxed only on any gain over $200 as capital gains.
However, in the very last part of section 988, the definition of “personal transactions” specifically EXCLUDES “any transfer to the extent that expenses properly allocable to such transaction meet the requirements of …section 212…”
Section 212 has to do with expenses related to the production of income, in other words, if the transaction involves expenses relating to the production of income, i.e., investment, the transaction is NOT considered to be a “personal transaction” under Section 988. Rather, it is an investment transaction. If someone has the dinars because they were actually in Iraq and had some left over that they’re now exchanging because they are not planning to go back to Iraq, that’s one thing. Although, even in that case, if they’ve been home in the US for 3 years now and have been holding on to their leftover dinars in anticipation of the RV, then it would appear that what was initially a “personal transaction” has now become an investment transaction.
Gains under Section 988 which are not “personal transactions” are taxed as ordinary income, and treated like interest.
Recently two tax attorneys and one CPA (the latter of whom who specializes in taxation of foreign currency trading transactions) have told me that the gains will be ordinary income under section 988, no matter how long a person has held them, not capital gains.
One of the attorneys that I had first consulted many months ago told me at that time that the gain would be treated as capital gains. When more recently I heard from these two other sources that it was all to be taxed as ordinary income under section 988, I contacted the first tax attorney again and explained that I had been given advice from other professionals that conflicted with his, and explained what they said, and asked if he could please either confirm his original advice or correct it. He corrected his.
So that is all to say that that one little paragraph in Publication 525 is correct as quoted, but unfortunately it fails to explain the very important point that “personal transaction” is a defined term in the code and it does not mean what we would like to think it means because our situation does not fit the exception it carves out for “personal transactions.”
So having said all that, perhaps you should share this information with your members so they can take . HAS THIS BEEN POSTED BEFOR???