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Financial Planning / Tax Strategies


Subject:  Re: Shorting Against the Box? Date:  12/8/1998  9:43 AM
Author:  TMFTaxes Number:  6880 of 124655

[[I will be in the lowest tax bracket next year (back to being a student) from a higher bracket this
year. I am getting more cautious on the market these days -- i hate this volatility -- but I want to
take my long-term gains next year when they will be taxed at only 10% as opposed to 20% if
possible. How can I lock in my gains at current prices but take the tax consequence next year? Do
I simply short against the box? If so, how do i do it? Thanks for any ideas.]]

The problem is that if you "short against the box", you may turn your long term gains into short term gains. In addition, if you short agains the box, you could run into trouble with respect to the new constructive sales rules.

Gain on closing a short sale is treated as short-term (regardless of the taxpayer's actual holding period for the property used to close the short sale) if the seller (a) owns 'substantially identical' property held for not more than one year at the time of the short sale or (b) acquires 'substantially identical' property after the short sale and on or before the closing date.

Gain on any part of the short sale, however, in excess of 'substantially identical' property held for not more than one year at the time of the short sale or acquired after the short sale and on or before the closing is not limited to a short-term capital gain.

For the purpose of this limitation on long-term capital gains, 'puts' or other options to sell at a fixed price are treated as short sales.

So you can certainly protect your gains, but you may impact the character of your gains. So you need to be careful.

In addition, the constructive sale rules can be a bit confusing.

If there is a constructive sale of an 'appreciated financial position', the taxpayer recognizes gain as if the position were sold, assigned, or otherwise terminated at its fair market value on the date of the constructive sale (and any gain must be taken into account for the tax year which includes that date). A constructive sale of an appreciated financial position occurs when the taxpayer (or a related person) enters into a short sale (or certain offsetting notional principal contracts or a futures or forward contract) of the same or substantially identical property.

But...there are exceptions to the constructive sale rules. For purposes of the constructive sale rules, any transaction (which would otherwise be treated as a constructive sale) during the tax year is disregarded if:
1. the transaction is closed before the end of the 30th day after the close of the tax year,
2. the taxpayer holds the appreciated financial position throughout the 60-day period beginning on the date the transaction is closed, and
3. at no time during that 60-day period is the taxpayer's risk of loss with respect to the position reduced by reason of a circumstance which would be described in Code Sec. 246(c)(4) (rules relating to suspension of the holding period where the risk of loss is diminished for purposes of the dividends received deduction) if references to stock included references to the position.

If a taxpayer meets the requirements described in (1) through (3) above, he can engage in transactions such as 'short sales against the box' (i.e., where a taxpayer borrows and sells shares identical to the shares the taxpayer holds) without a constructive sale occurring. But he must remain at risk with respect to the appreciated financial position for the sixty days after the closing.

If a taxpayer fails