Hugh Hewitt:
Re your request for information on Peabody Commodities:
This was apparently a vehicle set up to do tax straddles involving futures. This was a common tax reduction/avoidance strategy in the late-70s and early-80s. It allowed someone with a capital gain to defer payment of capital gains taxes.
Here's how it worked. Someone with a capital gain would buy and sell futures contracts (e.g., in gold), where the futures contract bought had a different expiration month (e.g., April 84) than that of the futures contract sold (e.g., July 84). Since the price of the future bought was closely related to the price of the future sold (since they were on the same underlying commodity) the overall risk of the straddle position is low if one position realized a big risk the other typically realized a big loss of almost equal magnitude. That was the rationale of the strategy regardless of what way prices moved, one of the two contracts (one of the legs of the straddle) would show a loss, even though the overall risk of the position was low.
At the end of the year, the individual would liquidate the leg of the straddle showing a loss. Given the tax laws at the time, the loss could be used to offset a capital gain on some other investment. The winning position was carried into the next tax year, and was liquidated soon after the turn of the year. The tax on the gain associated with this position was paid in that (next) year. Hence, this was a strategy for deferring capital gains taxes. At the time, interest rates were pretty high, leading to a sizable benefit from tax deferral. When interest rates are 12 percent, I can effectively reduce my tax by about 12 percent if I can defer paying for a year.
This was considered a highly abusive tax avoidance scheme, and Congress revised the tax code (in 1984 I believe) to eliminate this sort of activity. The new rule is referred to as the straddle rule. |
