The Straddle Tax Shelter

The IRS provided this detailed description of a partnership straddle tax shelter, a complex manipulation involving sequential steps. 1) A corporation acquires a majority interest in an upper-tier partnership (UTP) at fair market value. 2) The UTP acquires a majority interest in a lower-tier partnership (LTP) at fair market value. 3) The LTP enters into straddles on foreign currencies and may acquire other assets. 4) The LTP terminates the gain leg of a foreign currency straddle and allocates a pro rata share of the gain to the UTP, which in turn allocates a pro rata share of the gain to the corporation. This gain increases the basis of each partnership interest. 5) The corporation sells its interest in UTP to a taxpayer at fair market value. This results in a loss to the corporation sufficient to offset the gain that was allocated to the corporation. 6) The taxpayer purchases the UTP's interest in the LTP at fair market value. UTP realizes a loss on this sale, but the loss is disallowed under ? 707(b)(1)(A) because the taxpayer owns more than 50% of the UTP. 7) The LTP engages in a transaction that is intended to increase the taxpayer's basis in the LTP interest. For example, LTP may incur a liability that the taxpayer guarantees. The LTP then terminates the loss leg of the foreign currency straddle and allocates a pro rata share of the loss to the taxpayer. 8) The taxpayer sells the interest in LTP at its fair market value and realizes a gain (for example, from the relief of liability). Taxpayer then claims that this gain is offset under ? 267(d) by the amount of the loss that was disallowed to the UTP under ? 707(b)(1)(A).