Tax Brief

Internet Based Tax Briefing I

Facts

Haig Simmons operates an anthracite coal home heating and delivery service in Baltimore and Anne Arundel counties.  Ms. Simmons allows her customers to buy coal in advance at set prices and to pay for the coal ratably over a calendar year. Ms. Simmons enters into futures contracts to buy coal at a future date and at a set price to ensure she has a steady supply of coal, and to protect against price fluctuations. Upon the futures purchase, Ms. Simmons clearly indicates that it is simply a way to secure a supply of coal and to protect her from losses on her futures contracts with her customers. It is not an investment and Ms. Simmons does not intend to profit from the contract itself. Ms. Simmons suffered a loss on the futures contract due to the spot market rate of coal being lower on the day she acquired the coal than the futures contract price.

Issue

Can a taxpayer deduct for the loss incurred on the futures contract? If so, is it an ordinary loss or a capital loss?

Conclusion

In this situation, Haig Simmons will be able to deduct an ordinary loss on the futures contract.

Analysis

The Internal Revenue Code addressing whether the inventory is a capital asset or not is clearly defined in IRC Section 1221. IRC Section 1221defines a capital asset as “property held by the taxpayer (whether or not connected with his trade or business).” Continuing, IRC Section 1221 provides specific exclusions, including “ any hedging transaction which is clearly identified as such before the close of the day on which it was acquired, originated, or entered into”. Revenue Publication 544 (2012) indicates that capital assets generally fall into three categories, personal-use property, investment property and release of restriction on land. In addition, Revenue Publication 544 (2012) states stock in trade, inventory, and other property held mainly for sale to customers in trade or business...