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Author: gharnett Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121061  
Subject: Repeated shorts against the box Date: 2/21/2000 3:36 AM
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I have a question about shorting against the box. Below is a citation from a post by TMF Taxes (number 6880, 12/8/98). All the examples of shorting against the box that I have seen so far seem to presuppose a use of the strategy to defer taxable gains on the long position to the year immediately following the initiation of the offsetting short position. My question relates to a use of strategy for hedging, not tax deferral. Is it possible to open the offsetting short position, then close it, recognizing capital gain or loss on the short transaction but retaining the long position indefinitely without recognition of capital gain (or loss) on that long position until such time as the long position is sold, which might be many years -- not just the next year -- after the closing of the short position? Making use of the example taken from post 6880 as cited below, I've interjected the question "What if this is year 10?" in step 4 below. Would this modification of the example alter the account of taxable gain (or loss)? If not, is it safe to conclude that one may use this strategy repeatedly to hedge a long position, setting up offsetting short positions when one fears a market decline, then closing these positions, provided that, after the closing of the last of any series of such short positions, one leaves the long position unhedged for 60 days?

My thanks. The example follows below.

Gerald Harnett


Example: R, a calendar year taxpayer, has the following transactions in X Corp common stock:
. . . (1) Mar. 1, Year 1: bought 500 shares for $20,000.
. . . (2) Sept. 4, Year 4: borrows 500 shares from her broker and sells those shares short on that date for $40,000.
. . . (3) Jan. 15, Year 5: buys 500 shares for $35,000 and delivers those shares to her broker to close the short-sale transaction.
. . . (4) Mar. 20, Year 5 [WHAT IF THIS IS YEAR 10?] : sells her original 500 shares (the appreciated financial position) for $33,000.

Closing the short sale (transaction (3)) results in a short-term gain of $5,000 on transaction ($40,000 less $35,000).

The sale of her original shares on Mar. 20, Year 5 (transaction 4)) results in a long-term gain of $13,000 ($33,000 less $20,000).

Both the short-term gain of $5,000 and the long-term gain of $13,000 are taken into account in Year 5. There was no constructive sale in Year 4 since R closed the transaction before Jan. 31, Year 5, held her appreciated financial position throughout the 60-day period beginning on Jan. 15, Year 5, the day she closed the short sale made in Year 4, and her risk of loss with respect to her appreciated financial position was not diminished during that 60-day period.

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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: 29574 of 121061
Subject: Re: Repeated shorts against the box Date: 2/22/2000 11:30 AM
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<<I have a question about shorting against the box. Below is a citation from a post by TMF Taxes (number 6880, 12/8/98).>>

Do you really mean 1998? That was some time ago, and thing have changed and been updated since then. But let's move on.

<< All the examples of shorting against the box that I have seen so far seem to presuppose a use of the strategy to defer taxable gains on the long position to the year immediately following the initiation of the offsetting short position.>>

No...it's really used to "lock in" your gain in order to defer such gain into a later point in time...exaclty what your proposing. Shorting against the box never turned a short term gain into a long term gain. The law doesn't allow that.

<<My question relates to a use of strategy for hedging, not tax deferral. Is it possible to open the offsetting short position, then close it, recognizing capital gain or loss on the short transaction but retaining the long position indefinitely without recognition of capital gain (or loss) on that long position until such time as the long position is sold, which might be many years -- not just the next year -- after the closing of the short position?>>

No problem. As long as you follow the rules.

<< Making use of the example taken from post 6880 as cited below, I've interjected the question "What if this is year 10?" in step 4 below. Would this modification of the example alter the account of taxable gain (or loss)?>>

I'll try to follow the questions, but you might really want to visit the Taxes FAQ area and read more about the constructive sale rules. There are exceptions that you can use to avoid the imposition of the constructive sale rules. And those are the issues that you would be primarily interested in. Understanding those rules would allow you to "hedge" your position from time to time, and still avoid the trigger of the "sale" of your appreciated financial position.

<< If not, is it safe to conclude that one may use this strategy repeatedly to hedge a long position, setting up offsetting short positions when one fears a market decline, then closing these positions, provided that, after the closing of the last of any series of such short positions, one leaves the long position unhedged for 60 days?>>

There are more rules than just the 60 day rule. You also have to have to close your ofsetting position prior to January 31 of the following tax year. So a LONG market decline could cause you some problems.

<<Example: R, a calendar year taxpayer, has the following transactions in X Corp common stock:
. . . (1) Mar. 1, Year 1: bought 500 shares for $20,000.
. . . (2) Sept. 4, Year 4: borrows 500 shares from her broker and sells those shares short on that date for $40,000.>>

Right...constructive sale in year 4, unless the position is closed out appropriately.

<<. . . (3) Jan. 15, Year 5: buys 500 shares for $35,000 and delivers those shares to her broker to close the short-sale transaction.>>

The taxpayer has effectively shortstopped the imposition of the constructive sale rules.

<<. . . (4) Mar. 20, Year 5 [WHAT IF THIS IS YEAR 10?] : sells her original 500 shares (the appreciated financial position) for $33,000.>>

Completely immaterial. This could be year 5, 10, 25, or 75. All the taxpayer is doing is selling the original "long" position and finally realizing the gain.

<<Closing the short sale (transaction (3)) results in a short-term gain of $5,000 on transaction ($40,000 less $35,000).>>

Actually, since the "long" position was already a long term transaction at the time of the "hedge", any gain or loss on the "hedge" position would also be long term. This may have been a misstatement in the original post, but these rules follow the same pattern as the rules that will not allow the manipulation of gains or losses on underlying shares of stock.

<<The sale of her original shares on Mar. 20, Year 5 (transaction 4)) results in a long-term gain of $13,000 ($33,000 less $20,000).>>

Right.

<<Both the short-term gain of $5,000 and the long-term gain of $13,000 are taken into account in Year 5.>>

In this example, yes. But they would both be long term.

<< There was no constructive sale in Year 4 since R closed the transaction before Jan. 31, Year 5, held her appreciated financial position throughout the 60-day period beginning on Jan. 15, Year 5, the day she closed the short sale made in Year 4, and her risk of loss with respect to her appreciated financial position was not diminished during that 60-day period.>>

Yup...

Hope this helps...
TMF Taxes
Roy



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Author: gharnett Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29592 of 121061
Subject: Re: Repeated shorts against the box Date: 2/22/2000 1:33 PM
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My thanks, TMF Taxes (Roy), for the reply,

Which is the reply that I wanted to hear. My question was addressed only at the possibility of deferring gains on the long position to years farther out than the year immediately following the establishment of the offsetting short position. All the examples I've seen so far use as an example the year following, so it seemed to me possible that tax deferral on the long position was limited to one year: in other words, that one was going to pay the tax on the capital gains of that long position either in the year the short position was initiated, or in the year following, if the short position was closed by Jan. 31; but that the gain on the long position could not be deferred beyond that year. I saw nothing stating this point explicitly, but then I saw nothing stating otherwise and none of the examples encouraged a different interpretation.

Incidentally, apart from my interjected question, the cited text was composed by TMF Taxes (whoever that was) in 1998. I had no question involving the long- or short-term nature of the gain or loss in the offsetting short position.

My thanks again for the help. I'm posting this long reply just in case I've misconstrued any part of Roy's remarks.

Regards,

Gerald Harnett


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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: 29688 of 121061
Subject: Re: Repeated shorts against the box Date: 2/23/2000 8:53 AM
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<<. All the examples I've seen so far use as an example the year following, so it seemed to me possible that tax deferral on the long position was limited to one year: in other words, that one was going to pay the tax on the capital gains of that long position either in the year the short position was initiated, or in the year following, if the short position was closed by Jan. 31; but that the gain on the long position could not be deferred beyond that year.>>

Just as in my example, I'm sure that other have simply used the "next" year to show how the rules work. But, as you correctly point out, there is nothing that will cause you to close (either actually or constructively) the "long" end of the transaction for many years down the line...assuming that the constructive sale rules are followed with any subsequent hedging transactions.

<< I saw nothing stating this point explicitly, but then I saw nothing stating otherwise and none of the examples encouraged a different interpretation.>>

Now you got one!!

<<Incidentally, apart from my interjected question, the cited text was composed by TMF Taxes (whoever that was) in 1998. I had no question involving the long- or short-term nature of the gain or loss in the offsetting short position.>>

I guess that I'll have to find that FAQ and correct it. It must have been my evil twin that originally wrote it.

<<My thanks again for the help. I'm posting this long reply just in case I've misconstrued any part of Roy's remarks.>>

Nothing that I can see..
TMF Taxes
Roy


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