On August 6, 2026, the U.S. Tax Court issued its decision in SIH Partners LLLP v. Commissioner[1], denying approximately $170.8 million in qualified dividend income (“QDI”) treatment and roughly $25.6 million in foreign tax credits (“FTCs”) arising from a basket swap transaction in Swiss equities. The Court held that even though the taxpayer’s swap passed the mechanical “substantial overlap” test under the Treasury Regulations, the anti-abuse rule of Treasury Regulation § 1.246-5(c)(1)(vi) independently applied because the transaction was designed primarily to generate tax benefits rather than economic profit.

Although SIH Partners arose under the QDI and FTC holding-period rules, its implications for the taxation of hedge funds and other securities market participants are broader. Basket swaps are also used in loss-harvesting strategies under section 1091[2] and gain-deferral strategies under section 1259. Although SIH Partners did not decide the application of those provisions to basket swaps, it shows that formal differences in basket composition may not be enough where the positions are expected to track closely and the tax benefits materially exceed expected pre-tax economics.

Background

The taxpayer, SIH Partners LLLP, held long positions in four Swiss equities. Simultaneously, the taxpayer entered into a portfolio swap that gave it short exposure to those same Swiss equities, along with other equity positions that were part of a longstanding firm risk hedge. The swap substantially offset the economic exposure of the long positions while the taxpayer continued to hold the shares and receive the dividends. The key rule here was section 246(c)(4): days when a taxpayer’s risk of loss is reduced by positions in substantially similar or related property do not count toward the relevant holding period. Section 246(c) was originally enacted to prevent dividend stripping for purposes of the dividends-received deduction (DRD), but it also supplies the holding period rule for QDI treatment under section 1(h)(11)(B)(iii) and for FTCs on dividends under section 901(k)(5).

The transaction at issue involved what practitioners refer to as “70/30 baskets.” The taxpayer structured its portfolio swap so that the short side of the swap did not substantially overlap the long equity positions. The mechanical test under Treasury Regulation § 1.246-5(c)(1)(iii) treats positions as substantially similar or related property only if the overlap equals or exceeds 70%. The taxpayer’s long positions had only a 64% overlap with the swap’s reference portfolio, which was below the 70% threshold and thus passed the mechanical test.

The Tax Court’s Holding

Despite the taxpayer’s compliance with the mechanical “substantial overlap” test, the Tax Court separately applied the anti-abuse rule under Treasury Regulation § 1.246-5(c)(1)(vi). The anti-abuse rule is a backstop provision that allows the IRS to treat positions as substantially similar or related property, regardless of the 70% rule. The Court’s analysis turned on two findings:

  1. Virtual tracking. The Swiss equities and the short positions in the swap were reasonably expected to virtually track each other. Even though the mechanical overlap was below 70%, the long and short positions moved in lockstep as a practical matter, effectively neutralizing the taxpayer’s real economic risk in such investments.
  2. Tax savings exceeded economic profit. The transaction was part of a plan with a principal purpose of obtaining tax savings that were significantly in excess of the expected pre-tax economic benefits.

Because the anti-abuse rule was triggered, the Court treated the swap as a position in substantially similar or related property. The anti-abuse rule under Treasury Regulation § 1.246-5(c)(1)(vi) reaches QDI and FTC treatment because sections 1(h)(11) and 901(k)(1) each cross-references section 246(c) for their holding-period requirements, incorporating the full regulatory framework. This reduced the taxpayer’s holding period to zero, rendering the dividends ineligible for reduced tax rates under section 1(h)(11) and barring the FTCs generated by withholding taxes on those dividends under section 901(k)(1).

Implications for Other Tax Rules Related to Continued or Reduced Economic Exposure

Wash Sale Rules

Section 1091 generally disallows a loss if, during the 61-day period around a sale, the taxpayer acquires, or enters into a contract or option to acquire, “substantially identical” stock or securities. A basket swap loss-harvesting strategy may seek to preserve economic exposure while varying the reference basket enough to avoid that standard. SIH Partners does not define “substantially identical” under section 1091, but its focus on virtual tracking and tax-driven economics may give the IRS a stronger argument where the basket differs in form but closely replicates the sold position.

Constructive Sale Rules

Section 1259 is the closer statutory analogue. It generally treats an appreciated position as constructively sold when the taxpayer enters into an offsetting notional principal contract with respect to the “same or substantially identical” property, and it authorizes Treasury to reach other transactions with substantially the same effect. Hedge funds may use diversified basket swaps to reduce the overlap between an appreciated position and the offsetting basket while still materially hedging the economics. SIH Partners is especially relevant because section 1259(c)(3)’s closed-transaction exception expressly cross-references section 246(c)(4). Although SIH Partners did not involve section 1259, that cross-reference makes the Court’s focus on virtual tracking and reduced economic risk worth watching.

The takeaway is not that the 70% test in Treasury Regulation § 1.246-5 governs sections 1091 or 1259; it does not. Rather, SIH Partners cautions against treating basket composition as a stand-alone safe harbor. In either context, a basket with non-overlapping securities or positions may still draw added scrutiny if it closely tracks or offsets the original position or positions.

Broader Implications

  • A 70/30 structure is not a general safe harbor. The 70% test in SIH Partners belongs to the section 246 regulations, not sections 1091 or 1259. Still, the decision cautions against relying on a numerical overlap threshold where the basket’s economics closely replicate the direct position.
  • Listed transaction developments. The IRS has identified certain basket option contracts as listed transactions under Notice 2015-73 and as transactions of interest under Notice 2015-74. In July 2024, the IRS published proposed regulations (REG-102161-23) that would expand listed transaction treatment to a broader range of basket contract transactions. Participants in listed transactions are subject to mandatory disclosure and reporting obligations under sections 6011, 6111, and 6112, with significant penalties for noncompliance.

Hedge funds and other market participants using basket swaps for loss harvesting or gain deferral should review whether the non-overlapping components create meaningful economic differences or mainly formal ones. Relevant factors include how closely the basket tracks the sold or appreciated position, how much market risk remains, how the expected tax benefits compare with pre-tax economics, and whether any basket-contract disclosure rules apply. SIH Partners does not extend the section 246 anti-abuse rule to sections 1091 or 1259, but it makes the economic rationale for basket construction more important to document.

Our tax team is monitoring these developments closely and is available to assist clients in evaluating the impact of this decision on their existing and planned transactions.

We express special thanks to Sara Mungo, who contributed to the research and content of this update.

[1] 167 T.C. No. 8 (August 6, 2026).

[2] “Section” references are to sections of the Internal Revenue Code of 1986, as amended.

September 1, 2026