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Abstract: 

Proposed regulations on Section 263(g) released in 2001,1 requiring the capitalization of interest and carrying charges allocable to personal property that is part of a straddle, included an example indicating that interest paid on PHONES-type instruments would be covered by this rule. The broad reach of the proposed regulations produced considerable criticism from the practitioner community and the regulations have not been finalized. Nevertheless, the National Office, in TAM 200509022,2 has concluded that contingent payment debt instruments (CPDIs) referencing stock held by the taxpayer were positions with respect to substantially similar or related property (other than stock) with respect to the referenced stock. The National Office also concluded that payments on these PHONES-type instruments constituted interest and carrying charges incurred or continued to purchase or carry the stock, requiring capitalization. The Advice clearly indicates that the broad reading of Section 263(g) implicit in the proposed regulations retains favor inside of the IRS. The same overreaching can be said of the recent Technical Advice. It appears that even without solid regulatory back-up, the IRS is determined to put a chill on the use of instruments it does not like.

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