First, let’s describe what short selling means when you purchase shares of stock. In purchasing stocks, you buy a piece of ownership in the company. The buying and selling of stocks can occur with a stock broker or directly from the company.
When an investor or a trader goes short, he or she is anticipating a decrease in share price.
A short sale occurs when you agree to sell property you do not own (or own but do not wish to sell). You make this type of sale in two steps.
-
You sell short. You borrow property and deliver it to a buyer.
-
You close the sale; at a later date, you either buy substantially identical property and deliver it to the lender or make delivery out of property you held at the time of the sale. Delivery of property borrowed from another lender does not satisfy this requirement.
You do not realize gain or loss until delivery of property to close the short sale. You will have a capital gain or loss if the property used to close the short sale is a capital asset.
Now, let’s look at a couple scenarios: Suppose you sold Short Stock ABC and the stock became worthless before you covered your short. In that case, you must recognize gain as if the short sale were closed when the property became substantially worthless.
Another scenario involves what the IRS calls a constructive sale of property. In that case, you will have to recognize gain on the date of the constructive sale. Here is an example to make it easier to understand.
On May 8, 2016, you bought 100 shares of ABC Corporation stock for $1,000. On September 10, 2016, you sold short 100 shares of similar ABC stock for $1,600. You made no other transactions involving ABC stock for the rest of 2016 and the first 30 days of 2017.
Your short sale is treated as a constructive sale of an appreciated financial position because a sale of your ABC stock on the date of the short sale would have resulted in a gain. You recognize a $600 short-term capital gain from the constructive sale and your new holding period in the ABC stock begins on September 10.
As you may know, the IRS defines two types of capital gain. If you hold a position for more than a year it’s long term capital gain taxed for most Americans at 15%, and if you hold a position for a year or less it’s short term capital gain taxed at your ordinary income tax rate.
Generally, you determine whether you have short-term or long-term capital gain or loss on a short sale by the amount of time you actually hold the property eventually delivered to the lender to close the short sale.
Therefore, in most cases the short sale will be considered a short-term capital gain transaction.
Here is an example: Even though you do not own any stock of XYZ Corporation, you contract to sell 100 shares of it, which you borrow from your broker. After 13 months, when the price of the stock has risen, you buy 100 shares of XYZ Corporation stock and immediately deliver them to your broker to close out the short sale. Your loss is a short-term capital loss because your holding period for the delivered property is less than 1 day.
Special Rules
Special rules may apply to gains and losses from short sales of stocks, securities, and commodity and securities futures (other than certain straddles) if you held or acquired property substantially identical to property that sold short. But if the amount of property you sold short is more than the amount of that substantially identical property, the special rules do not apply to the gain or loss on the excess.
Gains and Holding Period
If you held the substantially identical property for 1 year or less on the date of the short sale, or if you acquired the substantially identical property after the short sale and by the date of closing the short sale, then:
Rule 1: Your gain, if any, when you close the short sale is a short-term capital gain, and
Rule 2: The holding period of the substantially identical property begins on the date of the closing of the short sale or on the date of the sale of this property, whichever comes first.
Losses
If, on the date of the short sale, you held substantially identical property for more than 1 year, any loss you realize on the short sale is a long-term capital loss, even if you held the property used to close the sale for 1 year or less. Certain losses on short sales of stock or securities are also subject to wash sale treatment.
Mixed Straddles
Under certain elections, you can avoid the treatment of loss from a short sale as long term under the special rule. These elections are for positions that are part of a mixed straddle.
As You can see selling short has many rules, regulations and elections. Your job is to focus on successful trades and our job is to offer you the tax strategies and recommendations that will minimize your tax liability and keep you in compliance.
This content is intended to provide educational information only. This information should not be construed as individual or customized legal, tax, financial or investment services. As each individual's situation is unique, a qualified professional should be consulted before making legal, tax, financial and investment decisions. The educational information provided in this article does not comprise any course or a part of any course that may be used as an educational credit for any certification purpose and will not prepare any User to be accredited for any licenses in any industry and will not prepare any User to get a job. Reproduced by permission from OTAcademy.com click here for Terms of Use: https://www.otacademy.com/about/terms
Editors’ Picks
USD/JPY holds above 155.50 ahead of BoJ policy announcement
USD/JPY is trading tightly above 155.50, off multi-year highs ahead of the BoJ policy announcement. The Yen draws support from higher Japanese bond yields even as the Tokyo CPI inflation cooled more than expected.
AUD/USD extends gains toward 0.6550 after Australian PPI data
AUD/USD is extending gains toward 0.6550 in Asian trading on Friday. The pair capitalizes on an annual increase in Australian PPI data. Meanwhile, a softer US Dollar and improving market mood also underpin the Aussie ahead of the US PCE inflation data.
Gold price keeps its range around $2,330, awaits US PCE data
Gold price is consolidating Thursday's rebound early Friday. Gold price jumped after US GDP figures for the first quarter of 2024 missed estimates, increasing speculation that the Fed could lower borrowing costs. Focus shifts to US PCE inflation on Friday.
Stripe looks to bring back crypto payments as stablecoin market cap hits all-time high
Stripe announced on Thursday that it would add support for USDC stablecoin, as the stablecoin market exploded in March, according to reports by Cryptocompare.
Bank of Japan expected to keep interest rates on hold after landmark hike
The Bank of Japan is set to leave its short-term rate target unchanged in the range between 0% and 0.1% on Friday, following the conclusion of its two-day monetary policy review meeting for April. The BoJ will announce its decision on Friday at around 3:00 GMT.
RECOMMENDED LESSONS
Making money in forex is easy if you know how the bankers trade!
Discover how to make money in forex is easy if you know how the bankers trade!
5 Forex News Events You Need To Know
In the fast moving world of currency markets, it is extremely important for new traders to know the list of important forex news...
Top 10 Chart Patterns Every Trader Should Know
Chart patterns are one of the most effective trading tools for a trader. They are pure price-action, and form on the basis of underlying buying and...
7 Ways to Avoid Forex Scams
The forex industry is recently seeing more and more scams. Here are 7 ways to avoid losing your money in such scams: Forex scams are becoming frequent. Michael Greenberg reports on luxurious expenses, including a submarine bought from the money taken from forex traders. Here’s another report of a forex fraud. So, how can we avoid falling in such forex scams?
What Are the 10 Fatal Mistakes Traders Make
Trading is exciting. Trading is hard. Trading is extremely hard. Some say that it takes more than 10,000 hours to master. Others believe that trading is the way to quick riches. They might be both wrong. What is important to know that no matter how experienced you are, mistakes will be part of the trading process.