Capital gains tax on inherited foreign currency

[brian94709]

I'm surprised I can't find a very clear statement about this online, as it seems like it wouldn't be such an unusual situation.

Suppose I inherit foreign currency, e.g. $100,000 Canadian dollars, but live and pay taxes in the United States. Let's say the date of death was January 1st 2024, I received the inheritance into my Canadian bank account on March 1st 2024. Then on May 1st 2024 I converted the currency to US dollars and transferred it to my US bank account.

I'm aware of the various reporting requirements, like FBAR, 8938 and 3520, this post is not about those.

If the US/Canadian dollar exchange rate changes over the year, do I have to pay capital gains tax for the exchange of the Canadian dollars to US dollars? If so, would the basis for this gain be based on January 1, or March 1 (i.e. the date of death, or the date the money was received)?

If the Canadian dollar actually decreased in value during this time, is this a capital loss that can be used to offset other capital gains?

[Mike9241]

the issue is that this would be covered by IRC section 988

(2)Exclusion for certain personal transactions
If—
(A)nonfunctional currency (the canadian $) is disposed of by an individual in any transaction, and
(B)such transaction is a personal transaction,
no gain shall be recognized for purposes of this subtitle by reason of changes in exchange rates after such currency was acquired by such individual and before such disposition. The preceding sentence shall not apply if the gain which would otherwise be recognized on the transaction exceeds $200.
(3)Personal transactions
For purposes of this subsection, the term “personal transaction” means any transaction entered into by an individual, except that such term shall not include any transaction to the extent that expenses properly allocable to such transaction meet the requirements of—
(A)section 162 - trade or business expenses (other than traveling expenses described in subsection (a)(2) thereof), or
(B)section 212 (expenses for the production of income) (other than that part of section 212 dealing with

expenses incurred in connection with taxes).

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so if the exclusion rule doesn't apply then section 988 covers the reporting

(1)Treatment as ordinary income or loss
(A)In general
Except as otherwise provided in this section, any foreign currency gain or loss attributable to a section 988 transaction shall be computed separately and treated as ordinary income or loss (as the case may be).

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(b)Foreign currency gain or loss
For purposes of this section—
(1)Foreign currency gain
The term “foreign currency gain” means any gain from a section 988 transaction to the extent such gain does not exceed gain realized by reason of changes in exchange rates on or after the booking date and before the payment date.

(2)Foreign currency loss
The term “foreign currency loss” means any loss from a section 988 transaction to the extent such loss does not exceed the loss realized by reason of changes in exchange rates on or after the booking date and before the payment date.

booking date would be the date of inheritance 1/1/2024 (valuation using spot rate)

payment date would be the date of sale 5/1/2024

in other words, gains/losses attributable to exchange rate fluctuation is ordinary income/loss not capital gain/loss.

[brian94709]

Thanks so much for your detailed response!

A few things that aren't 100% clear to me:

In section 988 2 B that you showed, it says the personal transaction exception doesn't apply if the gain on the transaction exceeds $200.  Would a loss of -$400 count here?  Or the exception can only apply to gains, not to losses?  If so that's kind of unfair no, that large gains get taxed, but large losses don't help in the other direction?

If I buy foreign currency explicitly with the hope that it will increase in value and then sell it, I guess that would be covered by 3B- expense for the production of income, so it wouldn't be considered a personal transaction?

Then what if I decided to hold onto the inherited currency- potentially for years- on the hope it would increase in value?