How to show currency loss in foreign CD due to exchange rate conversion?

[MS456]

Turbo Tax Experts,

I have replied to multiple posts (post1 , post2 ) on similar topic to get more information on this subject yesterday. I have not received any response yet as it has not been that long. But I think this is a common situation which should be clearly documented on Turbo Tax site to help people address this tax situation properly. Hence I decided to start a new post with all my findings so far and to get confirmation on those findings from the tax experts here.

Here is my tax situation:

I need to show foreign currency loss in the foreign CD and want to know if it should be shown as ordinary loss or capital loss on tax return. I transferred $25K in 2008 to India (in INR currency) and I invested the money in CD which gave good interest for which I paid taxes in US over the years by converting to USD using that year's exchange rate. In 2023, I converted that whole CD amount to USD. When I calculated the cost basis (by including all interests reinvested at different exchange rates), I can see I have a total of $30K loss. Should I show this as ordinary loss or capital loss on my 2023 tax return?

Here are my findings based on various articles:

1. Based on this article publication on ruchelaw.com , these should be treated as Section 988 transactions. Page #10 explains this: In general, Section 988 transactions include the following: Any disposition of any nonfunctional currency - For these purposes, nonfunctional currency includes coin and nonfunctional currency denominated demand or time deposits or similar instruments issued by a bank or other financial institution.

2. Section (9) Examples in this article from Cornell law site  (example 1 and 2) clearly explains that one can take losses when the individual actually convert the money from one currency to other. Examples mentions a personal loan but CD is also like a loan to the bank.  The first paragraph of same article says something like this which is confusing:

Coordination with section 988(c)(1)(C)(ii). No exchange gain or loss is recognized with respect to the following transactions -.

(A) An exchange of units of nonfunctional currency for different units of the same nonfunctional currency;

(B) The deposit of nonfunctional currency in a demand or time deposit or similar instrument (including a certificate of deposit) issued by a bank or other financial institution if such instrument is denominated in such currency. 

But I think the first paragraph of the article is just saying that one cannot take (unrealized) loss during the transactions such as moving money from one deposit to another in same non-functional currency (all points from A to E specifies almost same type of transfer or maturity of CD etc. ).  Individuals can adjust the basis as they are showing the interest every year as income but keeping the money invested in foreign currency till it is fully converted to USD.  Once money is converted from non-functional currency (ie foreign currency) to USD, a person can take the loss under section 988 (according to examples under section 9). 

3. According to this investopedia article , "foreign currency gain or loss on a 988 transaction is treated as ordinary income or loss unless an election is made to treat it as a capital gain or loss. For instance, if an investor makes an election before the transaction is entered into, they may be able to classify the gain or loss on a specific investment as a capital gain rather than ordinary income". My thoughts on this are: IRS wants us to make the election before we know if we will have gain or loss (currency exchange loss in our case) on this investment since treating "gain" as capital gain will benefit us (due to lower tax rate on capital gain vs ordinary income) while treating "loss" as ordinary loss will benefit us more (as ordinary loss can be fully used to offset ordinary income in a single year as opposed to capital loss which need to be spread across years if it is more than 3K). In my case I have not made any election so by default I should treat my loss as ordinary loss (not capital loss).

I know it is a long post but I wanted to consolidate all information from various posts and articles into a single post so anyone else facing the  same situation will find this helpful. 

Can the tax experts from TurboTax please review my post and confirm my understanding here? Also confirm if below steps to report this ordinary loss on tax return in Turbo Tax will be correct (I got these steps from similar posts on this site):

1. Go to Less common income 
2. Miscellaneous Income
3. Other Reportable Income
4. Enter description (Section 988 Forex Losses) and the loss as a negative amount

I will appreciate it if you can confirm soon as I need to submit my taxes in couple of days.

Thank you for your help!

MS

[Rotakie]

MS,

Thanks for a very detailed post. After many hours of research, I've come to the exact same conclusions as you. Logically a) IRS should allow the adjustment for losses, b) the losses should be offset against the ordinary income per irs reg 988, an c) the references to Time Deposits in 988 are merely a clarification that rolling over of CDs aren't a reportable event under 988.

However, we are not seeing any concrete or pursuasive response back from the experts. Given that Foreign CD is a very popular investment vehicle, you would expect a firm direction from the TurboTax team.

@DaveF1006 , @Mike9241,@ThomasM125, @pk, Please review and help us out here! Appeciate your support!

[Rotakie]

Also, see this past recommendation.

https://ttlc.intuit.com/community/tax-credits-deductions/discussion/how-to-report-interest-income-on...

[DaveF1006]

Here is a post that I wrote last year that may clear up some of the confusion that has been written on the subject. 

Coordination with section 988(c)(1)(C)(ii). No exchange gain or loss is recognized with respect to the following transactions -.

(A) An exchange of units of nonfunctional currency for different units of the same nonfunctional currency;

(B) The deposit of nonfunctional currency in a demand or time deposit or similar instrument (including a certificate of deposit) issued by a bank or other financial institution if such instrument is denominated in such currency. This is referring to conversion losses.

C. Thus gains or losses are not recognized in Section 988 transactions. 

CD's are considered time deposits like a savings account. You cannot report losses on savings accounts because of fluctuating interest rates or other environmental factors thus CD's are treated in the same manner in regards to currency conversions. It's a nature of the beast that we all must live with unless the tax code changes at some point. 

At this time, CD conversion losses are not recognized Section 988 losses.

@Rotakie 

[Rotakie]

Dave, thanks for a prompt response. I've checked your previous posts. However, as @MS456 has explained at great length above, the description regarding the Time Deposit explained at a great length on Cornell website as well as Ruchelaw seems to be clarifying that "unrealized" conversion from one CD to another does not result in an event to recognize gain/loss. Please see this verbatim from the Ruchelaw post, referenced by MS456 before.

Also, were you able to take a look at what @Mike9241 had recommended regarding USD/Lira conversion in the past. Can you please review this one time and opine? Appreciate your patience and support!

"Special Rules Relating to Certificates of Deposit
As noted above, certificates of deposit can be Section 988 transactions if
denominated in a foreign currency or if value is determined by reference to that
foreign currency. However, there are special rules with respect to certificates of
deposit. In particular, no exchange gain or loss is recognized with respect to the
following transactions:
• The deposit of nonfunctional currency in a demand or time deposit or
similar instrument (including a certificate of deposit) issued by a bank or
other financial institution if such instrument is denominated in such
currency;
• Withdrawal of nonfunctional currency from a demand or time deposit or
similar instrument issued by a bank or other financial institution if such
instrument is denominated in such currency;
• Receipt of nonfunctional currency from a bank or other financial institution
from which the taxpayer purchased a certificate of deposit or similar
instrument denominated in such currency by reason of the maturing or
other termination of such instrument; and
• The transfer of nonfunctional currency from a demand or time deposit or
similar instrument issued by a bank or other financial institution to another
demand or time deposit or similar instrument denominated in the same
nonfunctional currency issued by a bank or other financial institution.
For these purposes, the taxpayer's basis in the units of nonfunctional currency or
other property received in the transaction is the adjusted basis of the units of
nonfunctional currency or other property transferred.11"

@DaveF1006 , @MS456 , @Mike9241 

[Rotakie]

Also see this please from https://www.law.cornell.edu/uscode/text/26/988

"(C)Special rules for disposition of nonfunctional currency

(i)In generalIn the case of any disposition of any nonfunctional currency—

(I)

such disposition shall be treated as a section 988 transaction, and

(II)

any gain or loss from such transaction shall be treated as foreign currency gain or loss (as the case may be).

(ii)Nonfunctional currency

For purposes of this section, the term “nonfunctional currency” includes coin or currency, and nonfunctional currency denominated demand or time deposits or similar instruments issued by a bank or other financial institution.

[MS456]

I agree with this. From all articles I have seen so far including IRS publications, it is clear that the currency gain or loss should be taken when the currency disposition takes place (which is currency conversion in the case of foreign savings accounts whether it was saved in CD or just plain savings account or even given to someone as personal loan with the intention to receive interest from that person eg example 11 on page 18 in this post where X loans the amount to Y). 

[DaveF1006]

This is a very contentious issue that requires a great deal of interpretation.  I personally err on the side of caution and do not advise to declare a currency loss citing a Coordination with section 988(c)(1)(C)(ii). No exchange gain or loss is recognized with respect to currency losses regarding CD's or other demand/time deposits.

Any one reading this post has my blessing if they take an opposite position. If examined by the IRS, make sure you can support your position by all of thousands of references written on the subject. Ensure yourself it's an authoritative source such as the IRS or US Tax court.  The Tax Advisor and Cornell School of law are other excellent sources of information

[MS456]

I also want to say that I have posted my opinion based on all sources I have cited in this post. I also tried to contact IRS to get 100% confirmation, but was not able to do so. I could not find an option to put this question to IRS directly. So based on this information people should take the decision on their own.