In blog posts here and here I discussed the treatment of disposition gain by a taxpayer who sells a PFIC.  In those two blog posts I assumed that a taxpayer bought a PFIC and sold it in the same calendar year, and I further assumed there were no distributions by the PFIC.  (I am trying to define as clean and simple a fact pattern as possible so it is easy to identify the moving parts in the taxation of PFIC gain).

Disposition gain is ordinary income

My position was that the disposition gain is ordinary income.  One of my readers had a comment and question about how this worked, and whether in fact the disposition gain should be short term capital gain.  That would be logical.  🙂

The final answer is:  ordinary income.  You can see the reasoning in the other two blog posts, but my correspondent emailed me with his further research on the point and the way in which he came to the same conclusion.

§1.1291-3(a) says when you have a gain on sale of a PFIC look to §1.1291-2(e)(2), which talks about how the tax is figured, which is our case is ordinary income. It bypasses the calculation of the excess distribution, and that first year exception entirely. So, you are indeed correct.

Tracking the logic through the Proposed Regulations

Here’s what my correspondent is saying.  He points to Proposed Regulations Section 1.1291-3(a), which says:

Any direct or indirect disposition of stock of a section 1291 fund within the meaning of paragraphs (b), (c), (d), and (e) of this section is taxable to the extent provided in section 1291, this section, and section 1.1291-6. For dispositions of stock of a section 1291 fund that qualify for nonrecognition treatment, see section 1.1291-6. Gain is determined on a share-by- share basis and is taxed as an excess distribution as provided in section 1.1291-2(e)(2). Unless otherwise provided under another provision of the Code, a loss realized on a disposition of stock of a section 1291 fund is not recognized.

Emphasis added by yours truly.

Proposed Regulations Section 1.1291-2(e)(2) in turn says:


(i)  IN GENERAL.  To determine the taxation of an excess distribution, the excess distribution is first allocated pro rata to each day in the shareholder’s holding period (as determined under section 1.1291-1(h)) of the share of stock with respect to which the distribution was made. The holding period of a share of stock of a section 1291 fund is treated as ending on (and including) the date of each excess distribution solely for purposes of allocating the excess distribution.

(ii) ALLOCATIONS INCLUDED IN INCOME.  The portions of an excess distribution allocated to pre-PFIC years and the current shareholder year are included in the shareholder’s gross income for the current shareholder year as ordinary income.

(iii) ALLOCATIONS NOT INCLUDED IN INCOME.  The portions of an excess distribution allocated to prior PFIC years are not included in the shareholder’s gross income for purposes of this title. These amounts are subject to the deferred tax amount. The deferred tax amount is an additional liability of the shareholder for tax and interest for the current shareholder year. For the calculation of the deferred tax amount and the foreign tax credit that may be taken to reduce the deferred tax amount, see sections 1.1291-4 and 1.1291-5.

Here is how to understand that passage:

  1. First, you allocate the excess distribution pro rata across the holding period.  Prop. Regs. Sec. 1.1291-2(e)(2)(i).
  2. Then, take the amount that you have allocated to years before the PFIC was a PFIC, and include it in income as ordinary income.  The income is reported on the current year income tax return.  Prop. Reg. Sec. 1.1291-2(e)(2)(ii).
  3. Additionally, take the amount of gain you have allocated to the current year, and include it in income as ordinary income on your tax return.  Prop. Reg. Sec. 1.1291-2(e)(2)(ii).
  4. Finally, any excess distribution that is not allocated to the years in which the PFIC was not, uhhh, a PFIC, and any gain that is not allocated to the current year gets treated in a special way.  Don’t include it in the shareholder’s income for the current year.  Instead, you are going to do a special calculation which will result in a thing called the “deferred tax amount.”  Prop. Reg. Sec. 1.1291-2(e)(2)(iii).

As my correspondent points out, this logic tree completely bypasses the calculation of excess distribution–as well as the rules for the first year which define “total excess distribution” (not “excess distribution”) as zero in the first year of the holding period.  We are starting with the assumption that the disposition gain is excess distribution, because the Bible Internal Revenue Code told us so.  [Did that cue up a little song in your head from your childhood? It did for me. 🙂 ].

Internal Revenue Code Section 1291(a)(1)(B)(i) says:

(1) Distributions.  If a United States person receives an excess distribution in respect of stock in a passive foreign investment company, then–

(A) the amount of the excess distribution shall be allocated ratably to each day in the taxpayer’s holding period for the stock,

(B) with respect to such excess distribution, the taxpayer’s gross income for the current year shall include (as ordinary income) only the amounts allocated under subparagraph (A) to–

(i) the current year, or

* * * *.


Thanks to reader CP for this.  It forced me to go back and read the Code and Proposed Regs and think things through.  It is one of the reasons why releasing is so important. For those of you outside the priesthood of tax arcana, it gives you a glimpse into why tax law is so damned hard to do.

In conclusion, a simple declarative statement (because Don Schaut told me when I was a young pup lawyer that clients are grownups and deserve straight answers):

If you buy PFIC stock and sell it in the same year at a gain, the gain is treated as ordinary income, not short-term capital gain.