@MarkLondon , yes I have gone through section 988 and related areas. My opinion still is (a) you are taking on a debt not a debt instrument, this is your residence and not an investment ( it may work out to be ), for US tax purposes your functional currency is UKL ( and converted to US$ for recognition purposes). There is not gain in your functional currency by reducing your deductions for US tax purposes. In my view how is this any different from your original home loan at say 5% and later say refinanced at 3% in the USA ---- none. If I assume that your functional currency is your tax home currency, then again a similar situation would produce no taxable income ( because it is deduction only under USA mortgage interest deduction.).
Of course , if you do disagree and actually recognize the FX gain and pay taxes on this per section 988 and follow-on sections, IRS would be too happy without question.
On the forward hedging contract , it is different matter and yes section 988 recognition should apply.
It is your choice but my humble opinion to take the simplest interpretation still stand.
pk
