Subject: Tax Code - Short Sales Treatment

Last-Revised: 12 June 2008
Contributed-By: Art Kamlet (artkamlet at aol.com), Chris Lott (contact me)

What do you do if a short sale is open at the end of a calendar year? Brokerage houses report all sales (normal or short) on Form 1099-B as "sales", so you might think that you have to report it on your Schedule D to make the total sales number equal that reported to the IRS. But since the position is still open, the sale was not a taxable event. You sure don't want to pay tax on the amount of money you received when you went short!

I recommend that you report the short sale in the year of the sell transaction (when you went short), then back out any gain. One way to do this is as follows. On Schedule D Line 1 or line 8 (short-term or long-term), enter the short-sale amount. That will match the 1099-B totals with your reported Schedule D Sales column. Then right on the Schedule D include a back-out notation. For example:

DescriptionDate acquiredDate Sold Sales priceCostGain/loss
100sh XYZ CorpOPEN7/1/08 1000N/AN/A
NOTE: Above transaction is a short sale which remained open at year end

Remember that when the short position is finally closed out, the brokerage house will not make any indication on that year's 1099-B, but that's the year when you have to report the gain or loss realized in the transaction.

Is the gain or loss from the short transaction short-term or long term? Well, in a simple short sale trade you first borrow and sell stock to go short, then later buy back the stock to close the short position. So the only time you actually hold the stock is between when you buy the stock to cover the position and when you actually deliver that stock to close out the position. This length of time is somewhere from minutes to a few days. (Please see articles elsewhere in this FAQ explaining short sales, as well as long- and short-term capital gains.) So even if you go short, leave that position open for two years, then buy to cover, the gain or loss is short term. However, if you deliver stock held more than one year to cover a short position, that is long term regardless of how long the short position is open. Please see the relevant section in IRS publication 550 on short sales for a full discussion.

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