Modifications Of Nondebt Derivatives

A taxpayer generally realizes gain or loss from the sale or other disposition of property. More specifically, gain or loss is realized upon the exchange of property for other property that differs materially either in kind or in extent. As described in the Learning Annex below, special rules govern whether a modification of the terms of a debt instrument results in a taxable exchange. However, no specific rules address whether, and under what circumstances, a modification to the terms of derivatives (e.g., options, forwards or swaps) results in a taxable exchange. As a result, this determination is made on a case-bycase basis and depends on all the facts and circumstances. For this purpose, a structured note may be viewed as a nondebt derivative for federal income tax purposes and, to that extent, the same considerations would apply as in the case of derivatives not embedded in structured notes.