Section 988 - Certificate of deposit - loss of principal and interest due to devaluation of currency

[AC125]

A few years back, I invested in CDs overseas, in foreign currency and reported interest income, paid taxes annually. However starting last year I have started liquidating the CDs.. but when it coverts back to USD, the amount results in loss of principal and by the time i am done, likely going to lose all the interest on which I have paid income tax on. Can I report this loss under 'other income' schedule 1 line 8z as a negative number? (as per the discussion in the link below). Wanted to confirm if Certificates of deposits qualify under Sec 988

https://ttlc.intuit.com/community/tax-credits-deductions/discussion/how-do-i-report-foreign-exchange...

Secondly, does NJ recognize this loss and if so, where does this go on the NJ return? any negative number returns an error in Turbotax. 

[hbl3973]

AC125,

CDs are investments and in your situation I would follow the rules that can be used for bonds bought at a premium.  Report the CDs under the stocks and bonds area as either short term or long term investments where both the proceeds and the basis were not reported to the IRS.  (These are coded C and F on form 8949.)  Your cost basis is what you invested in $USD and your proceeds are what you received at maturity converted to $USD.

[AC125]

Thanks for the response. Like you said, typically capital assets like property or stocks will go through schedule D - capital gain (loss) via 8949. However, given that these losses on the CDs are exclusively due to foreign currency devaluation, shouldn’t the reporting be on schedule 1 under ordinary income gain (loss) as opposed to capital gain loss? (As per section 988)? 

[Mike9241 · Accepted solution]

nased on iRS regs 1.988-2

sold for E 950 @$.65

Under the general rules, T’s exchange loss is $50 ((€1,000 × $0.70) purchase price in US $ =$700  less the principal amount at the spot rate for date of sale (€1,000 × $0.65)). However, the overall economic loss on the sale is $82.50—the amount realized (€950 × $0.65, or $617.50) less the bond’s adjusted basis (€1,000 × $0.70, or $700). Thus, under the netting rule, T’s $82.50 overall economic loss consists of $50 ordinary exchange loss and a $32.50 market loss, which is capital in character; see Regs. Sec. 1.988-2(b)(9), Example (5)(ii).

now say sold for 950@$.40=$380, exchange loss $700 less 1000 *.4 = $400  exchange loss $300

economic loss $700-380 = $420  ordinary exchange loss 300 market/capital loss 120

[AC125]

Basically what you’re saying as per the example that the market loss is capital gains (loss) and currency change is ordinary gain (loss). 
In my example, it’s a CD. Hence, where there’s income (interest paid) as ordinary income which I have reported annually and paid taxes. And now I have currency loss, which should be ordinary loss as well. Example: $1000 invested in CD in foreign currency. Say $50 equivalent interest earned in year 1. Total value after growth in USD equivalent (held in foreign currency) = $1050. When I close the CD, I got back only $950 due to currency loss. So $100 should be deductible on schedule 1 - line 8z as a negative number -$100. Correct? 

[AC125]

Another thing I forgot to add.. in the above example, I already paid taxes on the $50 by adding it as ordinary income. 

[DaveF1006 · Accepted solution]

Yes, a $100 loss should be claimed as an ordinary loss in your return because of the currency conversion. As far as the taxes paid for the interest, the $100 loss that you will claim should more than offset that amount.

[AC125]

DaveF1006, Thanks!

Do you know if the same loss can be deducted in NJ tax return? If so, which form, what line? Will Turbo tax give an error with negative number in NJ return requiring manual filing, rather than e-file? thanks!

[DaveF1006 · Accepted solution]

i haven't found a credible NJ source that specifically excludes a Section 988 loss in NJ but I haven't found one that permits it either.

I have plugged a gain and a loss in my federal return. An ordinary gain was reported as income but the loss did not. New jersey does not accept negative adjustments of any kind. I even tried to enter a negative adjustment in the NJ return and it didn't accept. 

With this, i have to conclude that Section 988 losses are not deductible in NJ. I did find out that ordinary causality losses are not deductible and i feel that any ordinary loss is not deductible in the State of NJ.

[AC125]

Here's what I found on NJ tax return which confirms there cannot be a negative number FYI

Reporting Losses. If you have a net loss in any category of
income, remember the following:
• You cannot report a loss on your NJ-1040 (e.g., in parentheses or as a negative number);
• You can net losses with gains in the same category of
income. For example, you can subtract gambling losses
from gambling winnings during the tax year;
• You cannot apply a net loss in one category of income
against income or gains in a different category on your
NJ-1040. For example, you cannot subtract gambling
losses from your wages;
• If you have a net loss in any income category, make no
entry on that line of your NJ-1040. Do not enter zero. Do
not enter the amount of the loss in parentheses or as a
negative number;
• No carryback or carryover of losses is allowed when reporting income on your NJ-1040.

[DaveF1006]

Thank you for you research and posting the results of your research. This is solid confirmation that negative income cannot be reported in a New Jersey return

[dc20222023]

What if not convert it to another currency (unrealized loss), do we still pay taxes on the interests every year while the CD is losing value and less than previous year?

[AC125]

From what  I understand, you need to pay taxes on the interest income annually, regardless of the currency. Convert the interest earned annually to USD and report as ordinary income... even if the principal is losing value due to currency devaluation.

Once you pull the principal out and convert it to USD is when you utilize section 988 to claim loss of value of principal (and past interest earned) due to currency devaluation... as ordinary loss. 

[dc20222023]

Thanks!