Do I understand correctly. I go to Foreignland with $100 in my pocket, and buy Foreignmoney. The Foreignland economy does well, and their currency gets stronger. I then take this Foreignmony and buy $150. I have no capital gain.
I(f I were instead buy 100 Foreignmoney worth of Foreignstock. Later, when I sold the stock the price was still 100 in Foreignmoney. But I now buy $150 with the Foreigmoney. Now I have a capital gain of $50.
Here's what the IRS has to say:
"The functional currency of US taxpayers is generally the US dollar. If a US taxpayer engages in a transaction denominated in nonfunctional currency, it will most likely result in a foreign currency exchange gain or loss, separate from the underlying transaction.
"A foreign currency exchange gain or loss is the gain or loss realized due to the change in exchange rates between the booking date and the payment date of a transaction involving an asset or liability denominated in a nonfunctional currency. The gain or loss from disposing of nonfunctional currency is determined by the change in exchange rates between the date the nonfunctional currency was acquired and the date of disposition.
"Prior to the enactment of Internal Revenue Code (IRC) Section 988 under The Tax Reform Act of 1986, the treatment of foreign currency transactions was inconsistent. Determining the timing, amount, character, and source of the gains and losses that resulted from transactions in foreign currencies relied on court decisions and administrative rulings. These decisions were usually based on specific information relative to the transaction at hand.
"IRC 988 provides guidelines for the treatment of certain transactions denominated in a nonfunctional currency. These transactions include the acquisition of a debt instrument, or becoming the obligor of a debt instrument, accruing (or otherwise taking into account) any item of expense or income which will be paid or received after the accrual, entering into or acquiring any forward contract, futures contract, option, or similar financial instrument, and the disposition of nonfunctional currency. Definitions of specific transactions subject to IRC 988 will be the subject of a separate IPS unit.
"Under IRC 988(a)(1)(A), the foreign currency exchange gain or loss attributable to a Section 988 transaction is generally ordinary income. However, there are special rules, exceptions and elections which change the character of a Section 988 transaction; please see the Detailed Explanation of the Concept for examples of these rules, exceptions and elections. The foreign currency exchange gain or loss is separate from any gain or loss on the underlying Section 988 transaction. IRC 988 is principally a source and character provision.
"While IRC 988 addresses the 1) character, 2) source, 3) timing and
4) amount of gains and losses resulting from foreign currency transactions, this IPS unit will address only the character of foreign currency exchange gain or loss resulting from a Section 988 transaction. In general, a Section 988 transaction will result in a foreign currency exchange gain or loss that is ordinary. The remaining items related to gains and losses from transactions in foreign currency will be covered in other IPS units."You can read the entire document here:
First example: assuming the transaction was personal use (not an investment), then any exchange loss is not deductible, Any exchange gain that is greater than $199 per transaction would be ordinary gain. Any gain under $200 per transaction is not reportable. In your example, you have no gain of any kind to report.
Second example: you had a foreign investment account and bought and sold stock at the same price in foreign currency. But, as a US citizen or US resident those transactions are reported in US currency. You have a capital gain (long or short based on holding period) of $50 in your investment account.
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