DEFINITION of 'Section 988'

A financial transaction involving a capital loss or gain on an investment held in a foreign currency. A Section 988 transaction relates to IRS Section 988, which was applied to all tax years after December 31, 1986. Per IRS rules, most gains from foreign currency transactions are to be treated as ordinary income, whether earned by an individual or a corporation. Gains and losses from these transactions are typically viewed outside of any gain or loss due to exchange rate changes between the U.S. dollar and the foreign currency. 988 Transactions include those surrounding holders of foreign bonds (who will receive interest and principle in a domestically "nonfunctional" currency), foreign currency futures or other derivatives, as well as accrued expenses or receipts in a foreign currency.

BREAKING DOWN 'Section 988'

The most common securities affected include: futures positions, foreign exchange positions and international bonds. For instance, if a U.S. bank issues a bond that is denominated in the euro, it is considered a 988 transaction. If an investor makes an election before the transaction is entered into, he or she may be able to classify the gain or loss on a specific investment as a capital gain rather than ordinary income. This most often applies to forward contract transactions, options and futures.

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