Tax Consequences of Stock Short Sale

A short sale occurs when a taxpayer sells borrowed securities via a broker. It is easy to do this today through many different online brokers. The person engaging in this transactions wants the value of the stock to decline so that they can make a sale on the profit. If it does, he or she can buy the securities (at the lower price) to replace those borrowed and sold short, and profit from the price difference.

 

How are short sales gains treated for taxes?

The tax consequences of a short sale are similar to selling a security at a gain. Taxable gain or loss is computed based on the difference between the proceeds from the short sale and the tax basis of the securities delivered to cover. The holding period of the securities used to cover generally determines whether the gain or loss is short- or long-term. However, special holding period rules apply to prevent taxpayers from using short sales to convert short-term gains into long-term gains and long-term losses into short-term losses.

Special IRS Short Sale Tax Rules

  1. If, on the date of the short sale, substantially identical property has been held by the taxpayer (or spouse) for a period less than one year (or if substantially identical property is acquired after the short sale, but before the closing of the short sale by replacement of the borrowed securities), the holding period is deemed short-term regardless of how long the securities actually used to cover have been held. This rule applies only to gains.
  2. If, on the date of the short sale, substantially identical property has been held by the taxpayer (or spouse) for more than one year, any loss from the short sale will be deemed to be long-term regardless of the holding period of the securities actually used to cover. This rule applies only to losses.
  3. These deemed holding period rules apply only to the quantity of shares sold short.

 

Tax Consequences of Stock Short Sale

The term substantially identical property is to be applied according to the facts and circumstances in each case.