148 T.C. No. 13
Tax Ct.2017Background
- Andrew J. McKelvey entered into two variable prepaid forward contracts (VPFCs) in Sept. 2007 (with Bank of America and Morgan Stanley) and received large upfront cash prepayments in exchange for an obligation to deliver a variable number of Monster stock shares (or cash) on specified 2008 settlement/averaging dates.
- Each VPFC pledged the maximum number of shares deliverable as collateral and allowed the seller to settle with pledged shares, other shares, or cash; both contracts satisfied the IRS Rev. Rul. 2003-7 criteria and were treated as open transactions in 2007.
- In July 2008 McKelvey paid additional consideration to extend the settlement/averaging dates into 2010 (BofA and MSI extensions). He did not receive additional prepayments; the extensions preserved the other contract terms.
- McKelvey died later in 2008; the estate ultimately settled the contracts in 2009 by delivering shares.
- The Commissioner issued a deficiency for 2008, treating the 2008 extensions as (1) taxable exchanges under I.R.C. § 1001 (realizing large capital gain) and (2) constructive sales under I.R.C. § 1259. The estate petitioned the Tax Court.
Issues
| Issue | Plaintiff's Argument (Estate/McKelvey) | Defendant's Argument (Commissioner) | Held |
|---|---|---|---|
| Whether the 2008 VPFC extensions constituted a taxable sale or exchange under §1001 | Extensions merely postponed settlement/averaging dates; original VPFCs remained open transactions per Rev. Rul. 2003‑7, so no recognition in 2008 | Extensions closed/exchanged the original VPFCs for new instruments and therefore triggered realization under §1001 | Held for petitioner: extensions did not constitute taxable exchanges; open transaction treatment continued until actual settlement |
| Whether VPFCs were "property" of decedent at extension | VPFCs were not property after receipt of prepayments—decedent only had ongoing delivery obligations, not property rights | VPFCs contained valuable rights (use of prepayment, choice of cash vs stock settlement, collateral substitution) and thus were property | Held for petitioner: at extension decedent had only obligations (liabilities), not separable property interests under §1001 |
| Whether open-transaction treatment remained available after extensions | The extensions did not resolve uncertainty about which property would be delivered or its basis; therefore open transaction treatment should continue | Extensions altered the contracts in a way that closed original transactions, so open transaction doctrine no longer applied | Held for petitioner: open transaction doctrine continued because essential uncertainties (identity/basis of deliverable property) remained |
| Whether the extensions triggered constructive sales under §1259 | No; original VPFCs (which were open transactions and not forward contracts under §1259) remained operative and extensions did not create a §1259 forward or otherwise cause constructive sale | Extensions produced arrangements that should be treated as forward contracts or otherwise effect constructive sales of pledged shares | Held for petitioner: §1259 does not apply because original VPFCs were not §1259 forward contracts and remained open; no constructive sale on extension |
Key Cases Cited
- Dickman v. Commissioner, 465 U.S. 330 (definition of property includes bundle of rights)
- United States v. Craft, 535 U.S. 274 (state law defines sticks in bundle; federal law decides if those sticks are "property" for federal tax purposes)
- Lucas v. American Code Co., 280 U.S. 445 (realization principle)
- Burnet v. Logan, 283 U.S. 404 (open transaction doctrine)
- Virginia Iron Coal & Coke Co. v. Commissioner, 99 F.2d 919 (4th Cir.) (option continuation preserves open-transaction treatment)
- Fed. Home Loan Mortgage Corp. v. Commissioner, 121 T.C. 254 (discussing value of financing rights)
- Fed. Home Loan Mortgage Corp. v. Commissioner (Freddie Mac), 125 T.C. 248 (option-like commitments and open-transaction analysis)