Lot layering may help hedge funds improve the alignment between tax outcomes and the economic experience of their investors. Although lot layering is considered by most tax experts to be the most precise method of partnership allocations, this commonly understood precision is reduced upon redemptions due to the cumbersome and uneconomic basis adjustment method stipulated by Treasury regulations. We propose that changes be made to the current regulations that could remedy this problem. Despite its unavoidable deficiency caused by the basis adjustment requirements under the current regulations, we believe that lot layering aligns tax and economics more closely than do any of the “aggregation” methods presently used by most hedge funds.
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