Capital Gain Treatment of Currencies

I believe you only have to calculate the capital gain on currency holdings when you convert it back to US dollars. Otherwise you'd be paying taxes on unrealized currency gains. But some questions arise: is the gain ordinary or capital, are losses allowed.

The problem is the broker's 1099 will double count some part of a simple currency gain calculation. If the sequence is:

A) Buy Australian dollars with US dollars B) Buy at later date Australian stock X C) Sell Australian stock X D) Convert at later date Australian dollars to US dollars

The broker's 1099 makes a currency conversion calculation just to report the sale of stock in step C). If you need to report the currency gain or loss between A) and D), you somehow need to back out the component of that gain or loss already reported on the 1099 that reports steps B) and C).

It's tedious accounting at best.

If your accounting currency is USD, isn't step C really an exchange of the stock for AUD? Then step D is a sale of the AUD.

R's, John

Yes step C is a sale for AUD. The problem is that is not the way the broker

To do it as you suggest, how could you report the the capital gain or loss in C) without making a conversion to USD? In any case you would need to deviate from the broker's 1099-B, which carries its own issues.

I'm not sure there is any clean solution.

You might think so, but it still generates a capital gain transaction (which A and B don't, and D does).

Or, visit Australia and _spend_ the AUD (if AUD appreciated). There's no tax on the AUD appreciation that way.

Seth

An example might make understanding easier. Then 1099 tracks B and C. So suppose 1.3 USD = 1 EUR. You convert $100 to euros, getting 77 EUR, and immediately thereafter buy 77 EUR worth of stock. The stock rises to 100 EUR, but at that time the exchange rate is 1 USD = 1 EUR. You sell the stock, and immediately convert to dollars. The 1099-B has the cost as $100, and proceeds as $100, netting a profit of zero.

So the key is how are these international trading accounts set up. If the money is held in USD, and converted at the point of purchase and sale to/from the foreign currency, then there is no issue.

But if the account lets you hold international currency for a while then buy stock, then you have a problem. Because you will convert $100 to EUR, getting 77 EUR. You let the money sit there collecting EUR interest. Each interest payment must be converted on the day received to USD, and the broker can probably do that for you and put it on the 1099-INT. Suppose the interest is zero. Then you wait two months, the exchange rate changes to 1 USD = 1 EUR . Now you buy stock worth 77 EUR. Your purchase price ought to be $77, which is the purchase price of the stock. You sell the stock for 78 EUR, but by now the exchange rate is 1 USD = 0.9 EUR, so the sale price is

I have no idea how to handle this!

I'm not sure about that. It sounds like a loophole, and I'm sure some statute or law prohibits it.

Two errors here: the account has 79 EUR in it, not 1 EUR, after the sale for 78 EUR. You owe the IRS tax on $10 of gain, not $6.

You add the USD gain (or subtract the loss) to your basis in the EUR you hold. So, in the case of the sale for 78 EUR ($87 USD), you have 78 EUR with a cost basis of $110. If you then convert the EUR back to dollars when the exchange rate is $1 = 0.8 EUR, you receive $97.50 for a loss of $12.50 due to exchange rate fluctuations.

It's not a loophole. It's the same as if you were to travel to any other foreign country and spend dollars you converted into the local currency. There is no gain/loss due to exchange rates. Conversely, if you travel to a foreign country and convert USD into that currency and then convert the unspent local currency back into USD at the end of the trip, you can (and should, in principle) report the gain/loss due to exchange. This will almost always be a loss due to exchange fees and the spread between currency bid/ask rates.

Ira Smilovitz

You have to report a gain. A loss may be personal (e.g. vacation trip) hence not deductible.

Seth