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U.S. IRS questions hedge fund option strategy

WASHINGTON, Nov 12 (Reuters) - Certain hedge fund contracts styled as options should not be treated that way for tax purposes, U.S. tax authorities said, potentially knocking down a tax strategy that some investors use. At issue are hedge fund basket option contracts, where a taxpayer has an option to buy a basket of securities, but where the taxpayer takes most of the risk with opportunity for full gain or loss. The Internal Revenue Service in a memo released on Friday said in such cases "the taxpayer must currently recognize the trading gains, losses, income and expense resulting from trading and holding the securities in the basket." "The contract does not function like an option, and should not be treated as such," the associate chief counsel for the financial products unit at the Internal Revenue Service said in a memo dated Oct. 15 to staff. Although the memo, based on a current case, said it should not be treated as precedent, in practice such memos can guide future policy. It directs staff to gather information about similar cases so the IRS can decide whether a policy needs to be put in place to address "potentially abusive transactions." "We think this could have negative implications for other hedge funds and their prime brokers who may have similarly-structured arrangements," Anne Mathias, an analyst for investors at Washington Research Group said in an investment note. (Reporting by Kim Dixon. Editing by Robert MacMillan) Keywords: IRS HEDGEFUNDS/ Keywords: IRS HEDGEFUNDS/ (kim.dixon@reuters.com; +1 202 354-5864; Reuters Messaging:kim.dixon.reuters.com@reuters.net) COPYRIGHT Copyright Thomson Reuters 2010. All rights reserved.

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