PROVISIONS TO PREVENT CONVERSION OF ORDINARY INCOME TO CAPITAL GAIN.

SEC. 13206. PROVISIONS TO PREVENT CONVERSION OF ORDINARY INCOME TO CAPITAL GAIN. (a) Interest Embedded in Financial Transactions.— 107 STAT. 463 (1) In general.— Part IV of subchapter P of chapter 1 (relating to special rules for determining capital gains and losses) is amended by adding at the end the following new section: “SEC. 1258. RECHARACTERIZATION OF GAIN FROM CERTAIN FINANCIAL TRANSACTIONS. “(a) General Rule.— In the case of any gain— “(1) which (but for this section) would be treated as gain from the sale or exchange of a capital asset, and “(2) which is recognized on the disposition or other termination of any position which was held as part of a conversion transaction, such gain (to the extent such gain does not exceed the applicable imputed income amount) shall be treated as ordinary income. “(b) Applicable Imputed Income Amount.— For purposes of subsection (a), the term ‘applicable imputed income amount means, with respect to any disposition or other termination referred to in subsection (a), an amount equal to— “(1) the amount of interest which would have accrued on the taxpayer’s net investment in the conversion transaction for the period ending on the date of such disposition or other termination (or, if earlier, the date on which the requirements of subsection (c) ceased to be satisfied) at a rate equal to 120 percent of the applicable rate, reduced by “(2) the amount treated as ordinary income under subsection (a) with respect to any prior disposition or other termination of a position which was held as a part of such transaction. The Secretary shall by regulations provide for such reductions in the applicable imputed income amount as may be appropriate by reason of amounts capitalized under section 263(g), ordinary income received, or otherwise. “(c) Conversion Transaction.— For purposes of this section, the term ‘conversion transaction’ means any transaction— “(1) substantially all of the taxpayer’s expected return from which is attributable to the time value of the taxpayer’s net investment in such transaction, and “(2) which is— “(A) the holding of any property (whether or not actively traded), and the entering into a contract to sell such property (or substantially identical property) at a price determined in accordance with such contract, but only if such property was acquired and such contract was entered into on a substantially contemporaneous basis, “(B) an applicable straddle, “(C) any other transaction which is marketed or sold as producing capital gains from a transaction described in paragraph (1), or “(D) any other transaction specified in regulations prescribed by the Secretary. “(d) Definitions and Special Rules.— For purposes of this section— “(1) Applicable straddle.— The term ‘applicable straddle’ means any straddle (within the meaning of section 1092(c)); except that the term ‘personal property’ shall include stock. “(2) Applicable rate.— The term ‘applicable rate’ means— 107 STAT. 464 “(A) the applicable Federal rate determined under section 1274(d) (compounded semiannually) as if the conversion transaction were a debt instrument, or “(B) if the term of the conversion transaction is indefinite, the Federal short-term rates in effect under section 6621(b) during the period of the conversion transaction (compounded daily). “(3) Treatment of built-in losses.— “(A) In general.— If any position with a built-in loss becomes part of a conversion transaction— “(i) for purposes of applying this subtitle to such position for periods after such position becomes part of such transaction, such position shall be taken into account at its fair market value as of the time it became part of such transaction, except that “(ii) upon the disposition or other termination of such position in a transaction in which gain or loss is recognized, such built-in loss shall be recognized and shall have a character determined without regard to this section. “(B) Built-in loss.— For purposes of subparagraph (A), the term ‘built-in loss’ means the loss (if any) which would have been realized if the position had been disposed of or otherwise terminated at its fair market value as of the time such position became part of the conversion transaction. “(4) Position taken into account at fair market value.— In determining the taxpayer’s net investment in any conversion transaction, there shall be included the fair market value of any position which becomes part of such transaction (determined as of the time such position became part of such transaction). “(5) Special rule for options dealers and commodities traders.— “(A) In general.— Subsection (a) shall not apply to transactions — “(i) of an options dealer in the normal course of the dealer’s trade or business of dealing in options, or “(ii) of a commodities trader in the normal course of the trader’s trade or business of trading section 1256 contracts. “(B) Definitions.— For purposes of this paragraph— “(i) Options dealer.— The term ‘options dealer’ has the meaning given such term by section 1256(g)(8). “(ii) Commodities trader.— The term ‘commodities trader’ means any person who is a member (or, except as otherwise provided in regulations, is entitled to trade as a member) of a domestic board of trade which is designated as a contract market by the Commodity Futures Trading Commission. “(C) Limited partners and limited entrepreneurs.— In the case of any gain from a transaction recognized by an entity which is allocable to a limited partner or limited entrepreneur (within the meaning of section 464(e)(2)), subparagraph (A) shall not apply if— “(i) substantially all of the limited partner’s (or limited entrepreneur’s) expected return from the entity is attributable to the time value of the partner’s (or entrepreneur’s) net investment in such entity, “(ii) the transaction (or the interest in the entity) was marketed or sold as producing capital gains treatment from a transaction described in subsection (c)(1), or “(iii) the transaction (or the interest in the entity) is a transaction (or interest) specified in regulations prescribed by the Secretary.” 107 STAT. 465 (2) Clerical amendment.— The table of sections for part IV of subchapter P of chapter 1 is amended by adding at the end thereof the following new item: “Sec. 1258. Recharacterization of gain from certain financial transactions.” (3) Effective date.— The amendments made by this section shall apply to conversion transactions entered into after April 30, 1993. (b) Repeal of Certain Exceptions to Market Discount Rules.— (1) Market discount bonds issued on or before july 18, 1984.— The following provisions are hereby repealed: (A) Section 1276(e). (B) Section 1277(d). (2) Tax-exempt obligations.— (A) In general.— Paragraph (1) of section 1278(a) (defining market discount bond) is amended— (i) by striking clause (ii) of subparagraph (B) and redesignating clauses (iii) and (iv) of such subparagraph as clauses (ii) and (iii), respectively, (ii) by redesignating subparagraph (C) as subparagraph (D), and (iii) by inserting after subparagraph (B) the following new subparagraph: “(C) Section 1277 not applicable to tax-exempt obligations.— For purposes of section 1277, the term ‘market discount bond’ shall not include any tax-exempt obligation (as defined in section 1275(a)(3)).” (B) Conforming amendments.— (i) Sections 1276(a)(4) and 1278(b)(1) are each amended by striking “sections 871(a)” and inserting “sections 103, 871(a),”. (ii) Subparagraph (B) of section 1278(a)(4) is amended by inserting before the period at the end thereof the following: “or, in the case of a tax-exempt obligation, the aggregate amount of the original issue discount which accrued in the manner provided by section 1272(a) (determined without regard to paragraph (7) thereof) during periods before the acquisition of the bond by the taxpayer”. (3) Effective date.— The amendments made by this section shall apply to obligations purchased (within the meaning of section 1272(d)(1) of the Internal Revenue Code of 1986) after April 30, 1993. (c) Treatment of Stripped Preferred Stock.— 107 STAT. 466 (1) In general.— Section 305 is amended by redesignating subsection (e) as subsection (f) and by inserting after subsection (d) the following new subsection: “(e) Treatment of Purchaser of Stripped Preferred Stock.— “(1) In general.— If any person purchases after April 30, 1993, any stripped preferred stock, then such person, while holding such stock, shall include in gross income amounts equal to the amounts which would have been so includible if such stripped preferred stock were a bond issued on the purchase date and having original issue discount equal to the excess, if any, of— “(A) the redemption price for such stock, over “(B) the price at which such person purchased such stock. The preceding sentence shall also apply in the case of any person whose basis in such stock is determined by reference to the basis in the hands of such purchaser. “(2) Basis adjustments.— Appropriate adjustments to basis shall be made for amounts includible in gross income under paragraph (1). “(3) Tax treatment of person stripping stock.— If any person strips the rights to 1 or more dividends from any stock described in paragraph (5)(B) and after April 30, 1993, disposes of such dividend rights, for purposes of paragraph (1), such person shall be treated as having purchased the stripped preferred stock on the date of such disposition for a purchase price equal to such person’s adjusted basis in such stripped preferred stock. “(4) Amounts treated as ordinary income.— Any amount included in gross income under paragraph (1) shall be treated as ordinary income. “(5) Stripped preferred stock.— For purposes of this subsection— “(A) In general.— The term ‘stripped preferred stock’ means any stock described in subparagraph (B) if there has been a separation in ownership between such stock and any dividend on such stock which has not become payable. “(B) Description of stock.— Stock is described in this subsection if such stock— “(i) is limited and preferred as to dividends and does not participate in corporate growth to any significant extent, and “(ii) has a fixed redemption price. “(6) Purchase.— For purposes of this subsection, the term ‘purchase’ means— “(A) any acquisition of stock, where “(B) the basis of such stock is not determined in whole or in part by the reference to the adjusted basis of such stock in the hands of the person from whom acquired.” (2) Coordination with section 167(e).— Paragraph (2) of section 167(e) is amended to read as follows: “(2) Coordination with other provisions.— “(A) Section 273.— This subsection shall not apply to any term interest to which section 273 applies. 107 STAT. 467 “(B) Section 305(e).— This subsection shall not apply to the holder of the dividend rights which were separated from any stripped preferred stock to which section 305(e)(1) applies.” (3) Effective date.— The amendments made by this subsection shall take effect on April 30, 1993. (d) Treatment of Capital Gain Under Limitation on Invest.— (1) In general.— Subparagraph (B) of section 163(d)(4) (defining investment income) is amended to read as follows: “(B) Investment income.— The term ‘investment income’ means the sum of— “(i) gross income from property held for investment (other than any gain taken into account under clause (ii)(I)), “(ii) the excess (if any) of— “(I) the net gain attributable to the disposition of property held for investment, over “(II) the net capital gain determined by only taking into account gains and losses from dispositions of property held for investment, plus “(iii) so much of the net capital gain referred to in clause (ii)(II) (or, if lesser, the net gain referred to in clause (ii)(I)) as the taxpayer elects to take into account under this clause.” (2) Coordination with special capital gains rate.— Subsection (h) of section 1 is amended by adding at the end the following new sentence: “For purposes of the preceding sentence, the net capital gain for any taxable year shall be reduced (but not below zero) by the amount which the taxpayer elects to take into account as investment income for the taxable year under section 163(d)(4)(B)(iii).” (3) Effective date.— The amendments made by this subsection shall apply to taxable years beginning after December 31, 1992. (e) Treatment of Certain Appreciated Inventory.— (1) In general.— Paragraph (1) of section 751(d) is amended to read as follows: “(1) Substantial appreciation.— “(A) In general.— Inventory items of the partnership shall be considered to have appreciated substantially in value if their fair market value exceeds 120 percent of the adjusted basis to the partnership of such property. “(B) Certain property excluded.— For purposes of subparagraph (A), there shall be excluded any inventory property if a principal purpose for acquiring such property was to avoid the provisions of this section relating to inventory items.” (2) Effective date.— The amendment made by paragraph (1) shall apply to sales, exchanges, and distributions after April 30, 1993.