IRS written determination 201434024

Private letter rulings and published taxpayer determination letters. Native document type is retained separately; a determination letter is not labeled a private letter ruling. These taxpayer-specific releases cannot be used or cited as precedent under 26 USC 6110(k)(3); applicability and current legal force are not independently certified. Keep repeated UILC subjects attached to one actual numbered document.

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION
Number: 201434024
Release
Date: 8/22/2014
Date: May 29, 2014
UIL: 514.00-00; 514.06-00
Dear
DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224
Contact Person:
Identification Number:
Telephone Number:
Employer Identification Number:
This is
in response to your letter dated April 2, 2014, in which you requested certain rulings with
respect to I.R.C. § 514.
Background:
You represent that you are a qualifying charitable remainder unitrust under§§ 664(d)(2) and
664(d)(3). You propose to invest
in a number of funds that will be treated as partnerships for
tax purposes. You have represented that none of the partners
or brokers will be disqualified
persons as to you. The main activity of these funds
will consist of investing in stocks. These
funds seek to maintain a
neutral trading position as between short and long positions at all times
in order to minimize risks.
To facilitate your short positions, the funds will direct a broker to sell stock that the funds do not
own at the current price to a buyer
in the future. At the time that the short sale is settled the
funds must borrow stocks from the broker. The broker then provides those stocks to the buyer
at the agreed price creating an obligation by the funds toward the broker for the amount
of
securities loaned by the broker. The funds' creating income or loss is based on the difference
between the price at the time of the short
sale and the price at the time the sale is settled. The
broker often also charges a lending fee for this transaction as well.
In addition to the short position of the funds, the funds will also use the cash proceeds from the
short
sales to purchase long positions
in other stocks. Furthermore, the funds are required to
hold cash
in reserve to leverage other positions. These cash reserves may be required by law
or by the broker depending on the positions taken by the funds.
When a fund takes a long position
in a security it will acquire actual ownership of the security
and it
will not borrow money
from any other party to purchase
long positions
in securities. When
a fund takes a short position
in a security, it will do so by entering into a short sale with respect
to the security. Such short sales will be effected by borrowing the securities from a broker or
other third party and
collateralizing a fund's obligation to return such securities by depositing
cash and securities of equal value of the securities borrowed. Funds securities trades will
be

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executed through an unrelated third party, which will act as custodian of the securities. The
cash and securities used as collateral for such obligations will be assets owned by the fund and
in no case will such cash or securities be borrowed from outside sources. Thus, in no case in
which a fund takes a short position will there be any net borrowing by the fund on its own behalf
or on behalf of you. The amount
of the collateral deposited by a fund will equal at least 100
percent
of the amount of its obligations under existing short sale contracts. The value of any
securities placed on deposit as well as the amount of the fund's obligations under its short sale
contracts will be redetermined on a daily basis, and the fund will maintain sufficient reserves of
cash
or cash equivalents to meet requirements for any additional deposits which may be
required under applicable margin regulations.
A fund's deposit
of cash or securities will ensure the broker, and the parties with whom the
broker deals
in connection with the short sale transaction that the fund will be capable of
performing its obligations under its short sale contracts. While cash or securities are on deposit
with the broker, the fund will be entitled to receive any earnings which accrue thereon.
Similarly, the fund will be required to deliver, upon completion of a short sale, any earnings
which accrue during the term
of the contract.
Rulings Requested:
1. The borrowing of stocks by a fund in entering into short positions will not result in
"acquisition indebtedness" as defined in§ 514(c) so that none of the distributive share of
a fund's income or gain which is derived from the fund's trading activities, to the extent
attributable to the foregoing transactions, will be treated as "debt-financed property" as
defined
in § 514(b).
2. The purchase of long positions in stocks in accounts at one or more affiliates of a broker
using,
in whole or in part, cash proceeds from short sales made through a fund's
accounts at one or more affiliates of that same broker will not result in "acquisition
indebtedness" as defined
in§ 514(c) so that none of the distributive share of a fund's
income
or gain which is derived from the fund's trading activities, to the extent
attributable to the foregoing transactions, will be treated as "debt-financed property" as
defined
in§ 514(b).
3. The use of long positions in stocks, including some or all of those purchased with short
sale proceeds, as collateral to secure the performance by a fund of its obligations to
deliver stock to the broker to cover its open short positions will not result
in "acquisition
indebtedness" as defined in§ 514(c) so that none of the distributive share of a fund's
income or gain which
is derived from the fund's trading activities, to the extent
attributable to the foregoing transactions, will be treated as "debt-financed property" as
defined
in§ 514(b).
Law:
I.R.C. § 512(a)(1) provides that the term "unrelated business taxable income" means the gross
income derived by an organization from an
unrelated trade
or business (as defined in § 513)
regularly carried on by it, less the deductions allowed for expenses directly connected with the
carrying on of such trade
or business.

-------------------~
3
I.R.C. § 512(b)(1) excludes all dividends, interest, payments with respect to securities loans (as
defined
in subsection (a)(5)), amounts received or accrued as consideration for entering into
agreements to make loans, and annuities, and all deductions directly connected with such
income from the computation of unrelated business income.
I.R.C. § 512(b)(4) provides that Notwithstanding paragraph
(1 ), (2), (3), or (5), in the case of
debt-financed property (as defined in section 514) there shall be included, as an item of gross
income derived from an unrelated trade or business, the amount ascertained under section
514(a)(1), and there shall be allowed, as a deduction, the amount ascertained under section
514(a)(2).
I.R.C. § 512(b)(5) excludes the gains or losses from the sale
of property not held as inventory.
I.R.C. § 512(c)(1) provides that if a trade
or business regularly carried on by a partnership of
which an organization is a member
is an unrelated trade or business with respect to such
organization, such organization
in computing its unrelated business taxable income shall,
subject to the exceptions, additions, and limitations contained in subsection (b), include its share
(whether
or not distributed) of the gross income of the partnership from such unrelated trade or
business and its share of the partnership deductions
directly connected with such gross income.
I.R.C. § 514(a) provides that a portion of the income produced from debt-financed property shall
be included in unrelated business income in relation to the proportion of the overall value of the
property constituting "acquisition indebtedness."
I.R.C. § 514(b) defines "debt-financed property" as any property which is held to produce
income and with respect to which there is an acquisition indebtedness (as defined
in subsection
(c)) at any time during the
taxable year.
I.R.C. § 514(c) defines "acquisition indebtedness" as the unpaid amount of--
(A) the indebtedness incurred by the organization
in acquiring or improving such property;
(B) the indebtedness incurred before the acquisition or improvement
of such property if such
indebtedness would not have been incurred but for such acquisition or improvement; and
(C) the indebtedness incurred after the acquisition or improvement
of such property if such
indebtedness would not have been incurred but for such acquisition or improvement and the
incurrence
of such indebtedness was reasonably foreseeable at the time of such acquisition
or improvement.
I.R.C. § 664(c) provides that a charitable remainder unitrust, for any taxable year, is not subject
to any tax imposed by this
subtitle, unless the trust, for the year, has UBTI (within the meaning
of§ 512).
I.R.C. § 664(d)(2) defines the term "charitable remainder unitrust" to include a trust--
(A) from which a fixed percentage (which is not
less than 5 percent)
of the net fair

4
market value of its assets, valued annually, is to be paid, not less often than annually, to
one or more persons (at least one
of which is not an organization described in § 170( c)
and,
in the case of individuals, only to an individual who is living at the time of the
creation of the trust) for a term of years (not in excess of 20 years) or for the life or lives
of such individual or individuals,
(B) from which no amount other than the payments described in subparagraph (A) may
be paid to or for the use of any person other than an organization described
in§ 170(c),
and
(C) following the termination of the payments described in subparagraph A, the
remainder interest
in the trust is to be transferred to, or for the use of, an organization
described
in § 170( c) or is to be retained by the trust for such a use.
Revenue
Ruling 95-8, 1995-4 I.R.B. 29, provides that Income attributable to a short sale can
be
income derived from debt-financed property only if the short seller incurs acquisition
indebtedness within the meaning of§ 514 with respect to the property on which the short seller
realizes
that income. In Deputy v. duPont, 308 U.S. 488, 497-98 (1940), the Supreme Court
held that although a short sale created an obligation, it did not create indebtedness for purposes
of the predecessor of§ 163. Therefore, neither the $1 OOx gain realized by 0 on the short sale
attributable to the decline
in value of A stock from $5x to $4x nor income derived from the
proceeds
of the short sale, such as the rebate fee earned by 0, is income from debt-financed
property within the meaning
of§ 514.
Analysis:
Since you represent that you are a charitable remainder unitrust, you are governed
by§ 664(c).
This section subjects you to taxation on income that
qualifies as UBTI as defined by§ 512.
Section 512(b)(4) provides that, notwithstanding paragraphs (b)(1), (2), (3), or (5)
of§ 512, in
the case of debt-financed property certain items gross income and deductions shall be included
in the computation of unrelated business taxable income. Section 514(b) defines "debt-financed
property" as any property which is held to produce income and with respect to which there is
an
acquisition indebtedness at any time during the taxable year (or during the 12 months preceding
disposition
in the case of property disposed of during the taxable year). Section 514(c) defines
"acquisition indebtedness" as the unpaid amount
of the indebtedness incurred by the
organization
in acquiring the property and, in certain cases, indebtedness incurred before or
after the acquisition.
In accordance with§ 512(c)(1 ), a charitable remainder unitrust, which is a partner in a
partnership, is required to count as
UBTI its share of the partnership's gross income from
unrelated trade
or business. In making this calculation the modifications under§ 512(b) are
applicable, as well as the rules set forth
in§ 514 pertaining to unrelated debt-financed income.
Thus, in this case, your share of interest, dividends, or gains from the sale of property
attributable to your participation as a partner
in the funds would generally be excluded from the
computation of unrelated business taxable income, unless such amounts are derived from debt-
financed property.
Accordingly, dividends on your stock holdings earned while the stock is pledged as collateral

5
would be excluded from the computation of unrelated business taxable income under §
512(b)(1), and income received by you from the sale or exchange
of your securities would also
be excluded from the computation of unrelated business taxable income under§ 512(b)(5).
However, the modifications contained
in§ 512(b) are not available where such amounts are
derived from debt-financed property. Section 512(b)(4).
In Rev. Rul. 95-8, supra, we ruled that a short sale does not create an indebtedness for
purposes
of§ 514 because it constitutes the borrowing of property rather than money. Rev.
Rul. 95-8, supra, relies on Deputy v. duPont, 308 U.S. 488, in which the Supreme Court held
that a borrowing of property does not give rise to "indebtedness." The taxpayer borrowed stock
and argued that payments made to the
lender constituted interest. The court held that although
the taxpayer had an obligation to the lender, such obligation was not an "indebtedness,"
because an indebtedness
arises
only with respect to the borrowing
of money, not the borrowing
of property.
Based on the information presented, we
believe that none of the obligations that will be incurred
through the funds pursuant to the transactions described above will result
in acquisition
indebtedness
under§ 514(c)(1). Like the income received by the organization described in
Rev. Rul. 95-8, supra, your income which is attributable to a sale of publicly traded stock
through a broker will not be income derived from debt-financed property under§ 514 since the
borrowing
of the securities used in the short sale does not constitute acquisition indebtedness.
See also, Deputy
v. du Pont, 308 U.S. at 497-98. Since the income from the short sale will not
constitute debt-financed property, the long positions purchased using the cash proceeds from
those sales will also not be considered debt-financed property. Therefore, given that no long-
position stocks, cash reserves,
or short-sale stocks will be purchased using borrowed funds, the
income received by you from your participation
in the funds will not constitute income from
unrelated debt-financed property under§ 514.
Rulings:
1. The borrowing of stocks by a fund in entering into short positions will not result in
"acquisition indebtedness" as defined in§ 5l4(c) so that none of the distributive share of
a fund's income or gain which is derived from the fund's trading activities, to the extent
attributable to the foregoing transactions, will be treated as "debt-financed property" as
defined
in§ 514(b).
2. The purchase of long positions in stocks in accounts at one or more affiliates of a broker
using, in whole or in part, cash proceeds from short sales made through a fund's
accounts at one or more affiliates
of that same broker will not result in "acquisition
indebtedness" as defined
in § 514(c) so that none of the distributive share of a fund's
income
or gain which is derived from the fund's trading activities, to the extent
attributable to the foregoing transactions, will be treated as "debt-financed property" as
defined
in§ 514(b).

6
3. The use of long positions in stocks, including some or all of those purchased with short
sale proceeds, as collateral to secure the performance by a fund
of its obligations to
deliver stock to the broker to cover its open short positions will not result in "acquisition
indebtedness" as defined
in§ 514(c) so that none of the distributive share of a fund's
income
or gain which is derived from the fund's trading activities, to the extent
attributable to the foregoing transactions, will be treated as "debt-financed
property" as
defined
in § 514(b).
This ruling will be made available for public inspection under §
611 0 after certain deletions of
identifying information are made. For details, see enclosed Notice 437, Notice of Intention to
Disclose. A copy of this ruling with deletions that we intend to make available for public
inspection is attached to Notice 437. If you disagree with our proposed deletions, you should
follow the instructions
in Notice 437.
This ruling is directed only to the organization that requested
it. Section 6110(k)(3) provides
that it may not be used or cited by others as precedent.
This ruling
is based on the facts as they were presented and on the understanding that there will
be no material changes in these facts. This ruling does not address the applicability of any
section
of the Code or regulations to the facts submitted other than with respect to the sections
described. Specifically, this ruling does not reach any conclusion as to the qualifying distribution
status of your proposed transfer under § 4942(g)(3). Because it could help resolve questions
concerning your federal income tax status, this ruling should be kept in your permanent records.
If you have any questions about this ruling, please contact the person whose name and
telephone number are shown
in the heading of this letter.
In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we
are sending a copy of this letter to your authorized representative.
Enclosure
Notice 437
Sincerely,
Michael Seto
Manager,
EO Technical