US income tax provision on foreign currency gain or loss

Posted by Sanket Shah | General | Wednesday 30 May 2012 4:49 pm

Many of my friends called me last week from US and told me that many Indian banks were calling and suggesting them to transfer US dollars to India due to an all time high rate of Rupees 56 to a dollar.

Some of them actually did transfer some of their funds to the NRE accounts in India.

Most of them thought of making quick bucks if the Indian Rupee appreciates against the US Dollar in the near future.

Let us take a simple example:

Mr. X transfers USD $50,000 to an Indian NRE account at an exchange rate of $1 = Rs.56. That comes to Rs.2,800,000.

Now, let us assume Mr. X does nothing with the money that lying in his NRE account for a month (which is very doubtful ) and the Indian Rupee appreciates to $1 = Rs.50.

If Mr. X repatriates the money back to US, he would get $56,000.

Mr. X just made a gain of $6,000 due to exchange rate fluctuations without actually doing anything.

So now the big question, is this gain taxable?

Unfortunately, Yes under US IRC code 988.

Let me give you synopsis of the IRC code 988:

1. Where there are currency gains or losses in connection with a trade or business or with the management or administration of investment assets, the gain is treated as an ordinary gain (rather than as a capital gain) and any loss is generally treated as an expense.

2. Where currency gains or losses are incurred in connection with the purchase of an investment, the gain or loss on the currency change on realization (usually from selling) is a capital gain or loss and is included as part of the total capital gain or loss on the investment.

3. Currency gains of $200 or less that arise from personal transactions (not for investment or business) are not taxable, but any personal currency losses are not deductible.  A personal transaction includes any gain or loss arising from travel even if the travel is business related.

4. Any currency gains in excess of $200 per personal transaction (per trip or per purchase) are treated as a capital gain (long term or short term depending on your holding period).

The provisions of the IRC Code 988 are very complex and confusing.

It is very important that US Persons who have currency gain or losses consult their tax advisor before they disclose anything on their US income tax returns.

  • Chetan Popat

    Great article Sanket!!

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