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Author: CarlErikson Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121219  
Subject: Constructive sale tax law Date: 12/31/1999 5:19 PM
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Hello,

I think I may have found a discrepancy between IRS Publication 550 and the Motley Fool Tax FAQ in terms of constructive sales. I was just curious which interpretation is correct?

In Pub. 550, it says:

"
Exception for certain closed transactions. Do not treat a transaction as a constructive sale if all of the following are true.

1. You closed the transaction before the end of the 30th day after the end of your tax year.

2. You held the appreciated financial position throughout the 60-day period beginning on the date you closed the transaction.

3. Your risk of loss was not reduced at any time during that 60-day period by holding certain other positions.

If a closed transaction is reestablished in a substantially similar position during the 60-day period beginning on the date the first transaction was closed, this exception still applies if the reestablished position is closed before the end of the 30th day after the end of your tax year in which the first transaction was closed and, after that closing, (2) and (3) above are true.
"

Note this last paragraph on reestablishing a position. In the Motley Fool Tax FAQ, it states,

"
One very important thing that you should remember: Once you meet the constructive sale rules exceptions, you are then allowed (should you desire) to enter into ANOTHER offsetting position. But you'll have to be sure that you meet the exceptions for the NEW offsetting position.
"

This is not equivalent to what the IRS Pub. 550 says. I.e., suppose I was long 100 shares of MSFT since 1/1/1999. Then I went short 100 shares of MSFT on 10/1/1999 and closed the short position on 10/2/1999. Then I went short 100 shares of MSFT on 10/15/1999 and then closed the short position on 10/16/1999. 60 days after 10/16/1999, if I have held the original 100 shares of MSFT, then according to the IRS Pub. 550, there is no constructive sale. According to the Tax FAQ, there is.

Who is right?

Thanks,
Carl Erikson
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Author: TMFTaxes Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 24243 of 121219
Subject: Re: Constructive sale tax law Date: 1/2/2000 1:52 PM
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<<I think I may have found a discrepancy between IRS Publication 550 and the Motley Fool Tax FAQ in terms of constructive sales. I was just curious which interpretation is correct?>>

OK...I'll see what I can do for you, Carl.

<<In Pub. 550, it says:
"
Exception for certain closed transactions. Do not treat a transaction as a constructive sale if all of the following are true.
1. You closed the transaction before the end of the 30th day after the end of your tax year.
2. You held the appreciated financial position throughout the 60-day period beginning on the date you closed the transaction.
3. Your risk of loss was not reduced at any time during that 60-day period by holding certain other positions.>>

Right...and...hopefully...this is the same thing that the FAQ has to say. But let's read on.

<<If a closed transaction is reestablished in a substantially similar position during the 60-day period beginning on the date the first transaction was closed, this exception still applies if the reestablished position is closed before the end of the 30th day after the end of your tax year in which the first transaction was closed and, after that closing, (2) and (3) above are true.">>

Right again...This gets a little complicated to understand, but it deals with contstructive sales that close BEFORE the end of the tax year, then re-established, and then again closed using the issues noted in (2) and (3) above.

<<Note this last paragraph on reestablishing a position. In the Motley Fool Tax FAQ, it states,
"
One very important thing that you should remember: Once you meet the constructive sale rules exceptions, you are then allowed (should you desire) to enter into ANOTHER offsetting position. But you'll have to be sure that you meet the exceptions for the NEW offsetting position."

Right...what this paragraph was designed to point out is that once you "close" your position, wait the required 60 days after closing, you can THEN create another offsetting position. But doing this, you have avoided the constructive sale rules, but have created another "offsetting" position.

But this paragraph has really nothing to do with the paragraph noted above. It's a completely separate transaction in the following year. From that standpoint, it may be a bit misleading.

<<This is not equivalent to what the IRS Pub. 550 says. I.e., suppose I was long 100 shares of MSFT since 1/1/1999.>>

OK...

<< Then I went short 100 shares of MSFT on 10/1/1999 and closed the short position on 10/2/1999.>>

OK...you have now closed your hedge transaction. I don't know why you would "hedge" for only one day...but it's your example. As long as you hold your "long" position for 60 days from 10-2-99, you have no constructive sale.

<< Then I went short 100 shares of MSFT on 10/15/1999 and then closed the short position on 10/16/1999.>>

Because of the 10-15-99 purchase, you have "re-established" your position, and the constructive sale rules again apply. But again, you close the short position on 10-16-99. So as long as you hold your long position for 60 days after you close your "hedge", you can ignore the constructive sale rules.

<< 60 days after 10/16/1999, if I have held the original 100 shares of MSFT, then according to the IRS Pub. 550, there is no constructive sale. According to the Tax FAQ, there is.>>

And I would agree with your assessment above. The problem is: I can't see where the FAQ states that there WOULD be a constructive sale here. Because I wrote the constructive sale FAQ, I may be a bit "blind" to what the words really meant to another person.

So let me "parse" the paragraph that you have referenced (even though it is taken completely out of context):

<<One very important thing that you should remember: Once you meet the constructive sale rules exceptions, you are then allowed (should you desire) to enter into ANOTHER offsetting position.>>

Right...you ARE allowed to enter into another ofsetting position. This doesn't really discuss the issues in your post. It deals with a trader that meets the rules, and then wants to hedge (for longer than a day or two). Take this example. Originally buy 100 shares STOCK on 1-1-99. Short 100 shares STOCK on 11-1-99. Close short position on STOCK on 12-1-99. Retain the "long" position in STOCK for at least 30 days. On 2-10-2000, again short 100 shares of STOCK. You are now againg hedged, and you have avoided the constructive sale rules for 1999. So, what I'm saying is that as long as you meet the constructive sale rules, you are allowed to re-establish a hedge position...bridging two separate tax years.

<< But you'll have to be sure that you meet the exceptions for the NEW offsetting position.">>

What I was trying to say is that for the NEW position, the rules begin all over again. In my example above, you would have to close your 100 short position on STOCK on or before 12-30-2001, and remain in the long position for at least 60 days after the short position is closed.

<<Who is right?>>

I think that we both are...but I'm having trouble seeing exactly what the problem is. Hope this explanation helps a bit.

TMF Taxes
Roy



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Author: CarlErikson Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 24269 of 121219
Subject: Re: Constructive sale tax law Date: 1/3/2000 1:05 AM
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Thanks for your reply, Roy!

I guess I was confused about the context of that paragraph that I cited from the MF Tax FAQ. Now that you made it clear that you were talking about hedge positions in two different tax years, it all makes sense. So yes, both the IRS Pub. 550 and the FAQ present the same interpretation.

Sorry for the confusion,
Carl


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