Interest Rate Hedging in a Volatile Market

Taxpayers routinely enter into interest rate swaps to manage interest rate risk on their debt issuances. These interest rate swaps are subject to special tax-hedging rules intended to clearly reflect income by matching the recognition of gain or loss on the hedging transaction with the recognition of income, deduction, gain or loss on the hedged debt instrument. The current interest rate environment has resulted in large gains or losses on interest rate swaps, which magnifies certain issues that can arise when applying this matching principle. This article reviews these challenges and highlights the uncertainties that arise when applying the matching principle to situations in which either the debt instrument or the interest rate swap is modified or terminated.