NEW YORK (Reuters) - American International Group Inc's talks with the US Treasury Department over the repayment of taxpayer funds have advanced past initial discussions, a source familiar with the matter said yesterday.

A possible conversion of the Treasury's $49 billion preferred stake in AIG into common stock is one of the options being discussed, the source said, who declined to be named because the talks are not public.

AIG, which received a $182.3 billion US rescue package after being bailed out two years ago, must first pay back its debt to the Federal Reserve Bank of New York.

AIG owes the Fed about $21 billion under a credit facility. The Fed also owns $25 billion worth of preferred interest in two of AIG's foreign life insurance units that must be monetised. The company expects a big part of that money to come in by the end of the year, as it closes on the sale of American Life Insurance Co to MetLife Inc for $15.5 billion.