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Author: CarlErikson Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121268  
Subject: One more try Date: 11/9/1999 11:17 AM
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Hello,

I haven't had much success with answers to this question, but I'll try one more time. Sorry to keep bothering everybody!

Hypothetical situation:

Suppose I own 1,000 shares of YHOO at Schwab and have held these shares since 1995.

Now suppose I make a living off of playing market-maker. I have one account (say Waterhouse) where I try to buy stocks on the bid. And then I have another account (say Datek) where I attempt to sell at the ask simultaneously.

One day, I decide to play market-maker in YHOO. I successfully and simultaneously buy 1,000 shares long of YHOO at Waterhouse and short 1,000 shares of YHOO at Datek, capturing a 1/4 spread for a small profit.

I exit both sides of the position later in the day to capture this small profit.

Note that since the buy and sell transaction of 1,000 shares on Waterhouse is in a different account than my long-term holdings at Schwab, the 1,000 shares sold can be "identified" as the 1,000 shares I purchased a few hours earlier in the Waterhouse account.

Now, the "intent" of the short position I undertook on Datek was used to hedge the position on Waterhouse, and not my long-term holdings at Schwab. However, as far as I can tell I have no legal way of claiming that this short position was to hedge the long position on Waterhouse and not the one on Schwab.

My question is - what are the tax implications of these transactions? In other words, would the short position on Datek be deemed a "constructive sale" on the Waterhouse shares or Schwab shares? Or can I "identify" which shares the short position hedged? If so, how? By keeping good records?

Thanks for any help you can give me,
Carl Erikson
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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20768 of 121268
Subject: Re: One more try Date: 11/9/1999 12:52 PM
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I haven't had much success with answers to this question, but I'll try one more time. Sorry to keep bothering everybody!

Patience, Carl, patience. Everyone contributing to this board is a volunteer. We all make a living doing somethine else. Personally, I was going to pass on trying to answer your question, but I stumbled onto what I think you're talking about while researching the "wash sale" question.

First post:
Is there a definition of "substantially identical property" somewhere? Suppose I have an account that contains 100 shares of Yahoo! and has been held long term. However, suppose I also want to actively trade in this account and I short 500 shares of Yahoo! and then close this position a day later. Is this considered a "constructive sale" even though in my mind I am not touching the original 100 shares during this transaction? Can I "specify" that these 500 shares are completely different than the 100 shares of YHOO that I originally purchased several years earlier?

Second post:
Suppose I hold 100 shares of MSFT long and have owned the shares since 1995. Now, because I am an unfoolish active trader, I decide to short 700 shares of MSFT for trading purposes, and not to do a "short sale against the box." I cover these 700 shares of MSFT a few days later (within the '99 tax year). Does the fact that the number of shares differ in these transactions (100 vs. 700) make any difference in terms of whether there was a "constructive sale" due to the first 100 shorted shares of the transaction? I.e., can I prove that my intent was to short-term trade these 700 shares and not touch my long-term holdings in the process?

These two appear to be basically the same question. What you are describing is the constructive sale rules at IRC Sec. 1259. The general rule is that if you sell short a position that you also hold long, it will be deemed a sale of the long position and any gain would be taxable at that time. There is an exception, however. If you close the short position in the same tax year, or within 30 days of the end of the year, the constructive sale rule will not apply and you will keep the long position and pay tax on any gain or loss in the short and subsequent cover. This has nothing to do with the specific identification method for accounting for sales of long positions in a security.


Third post:
Hypothetical situation:

Suppose I own 1,000 shares of YHOO at Schwab and have held these shares since 1995.

Now suppose I make a living off of playing market-maker. I have one account (say Waterhouse) where I try to buy stocks on the bid. And then I have another account (say Datek) where I attempt to sell at the ask simultaneously.

One day, I decide to play market-maker in YHOO. I successfully and simultaneously buy 1,000 shares long of YHOO at Waterhouse and short 1,000 shares of YHOO at Datek, capturing a 1/4 spread for a small profit.

I exit both sides of the position later in the day to capture this small profit.

Note that since the buy and sell transaction of 1,000 shares on Waterhouse is in a different account than my long-term holdings at Schwab, the 1,000 shares sold can be "identified" as the 1,000 shares I purchased a few hours earlier in the Waterhouse account.

Now, the "intent" of the short position I undertook on Datek was used to hedge the position on Waterhouse, and not my long-term holdings at Schwab. However, as far as I can tell I have no legal way of claiming that this short position was to hedge the long position on Waterhouse and not the one on Schwab.

My question is - what are the tax implications of these transactions? In other words, would the short position on Datek be deemed a "constructive sale" on the Waterhouse shares or Schwab shares? Or can I "identify" which shares the short position hedged? If so, how? By keeping good records?



You've added a small twist in that we now know that the short position was covered before the end of the tax year. I'm more confident that the exception in IRC Sec. 1259 would apply to these facts. Once again, specific identification is not the issue, the constructive sale of a long position is the issue.

Important disclaimer:
I have never personally worked with the constructive sale rules. Before attempting this, I would want to talk to someone who has, preferably in an audit situation.

--ptheland

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Author: CarlErikson Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20769 of 121268
Subject: Re: One more try Date: 11/9/1999 1:36 PM
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<You've added a small twist in that we now know that the short position was covered before the end of the tax year. I'm more confident that the exception in IRC Sec. 1259 would apply to these facts. Once again, specific identification is not the issue, the constructive sale of a long position is the issue.>

Thanks for the reply! However, in my hypothetical scenario, it makes a big difference whether the Schwab or Waterhouse shares were considered to be the ones involved in the "constructive sale." I.e., if they are the Schwab ones, I pay a huge long-term capital gains tax. If they are the Waterhouse ones, then I pay a small short-term capital gains tax. And even if I qualify for the exception in IRC Sec. 1259, again it matters a great deal which shares were involved in that transaction. If they are the Schwab ones, then my holding period starts afresh on the day of the short sale - making them short-term holdings even though I've held them for several years. If they are the Waterhouse ones, then I can still retain my long-term holding period on my original YHOO shares. Therefore, being able to "identify" which shares were involved in this transaction makes a big difference.

Thanks again for reading this,
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: 20811 of 121268
Subject: Re: One more try Date: 11/9/1999 8:43 PM
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<<I haven't had much success with answers to this question, but I'll try one more time. Sorry to keep bothering everybody!>>

I think I answered it not more than 20 minutes ago...along with a second question that you also asked.

The resonses should be posted by now. Check 'em out.

TMF Taxes
Roy



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