Margin Call Losses

[jbuob]

When the Feds sell stock to satisfy a margin loan, and the client only gets about a third of the money, can the client use the margin loan payoff amount as an investment expense and if so, where do you claim it or what form is used? Thanks, JB

[Koss]

Margin Call

Okay, I'm gonna take this one...

What do you mean "when the Feds sell stock to satisfy a margin loan, and the client only gets about a third of the money"?

Is your client an individual?

The Feds do not "sell stock to satisfy a margin loan." The only context in which this be would remotely possible is if your client was a large institutional investor such as a pension plan or a hedge fund, or if your client was a broker that had become insolvent, like Lehman Brothers. The "feds" don't sell anything, unless a federal agency, such as the SEC, or the FDIC or SIPC, has taken control of the company.

I'm going to try to answer your question, but you need to provide more information.

My educated guess is this:

* * * * *

Your client bought stock by borrowing money on a margin loan.

A margin loan means that your client put up some other stock as collateral for the loan.

The stock that was put up as collateral dropped in value, to the point where it was no longer sufficient to secure the loan.

The broker issued a margin call, which is a fancy way of saying, "You have to put up more stock as collateral, or you have to pay back part of the loan, because the stock you put up as collateral is no longer worth enough to secure the loan."

Your client did not respond to the margin call, i.e., he didn't put up more stock as collateral, and he didn't pay back part of the loan.

The broker (not the Feds) sold some (or all) of the stock that your client bought with the money that he borrowed. This is not the same as selling the stock that was put up as collateral This was done by the broker because the loan became too risky. The loan became too risky because the collateral for the loan was worth only a fraction of what it was worth when your client originally borrowed the money. The proceeds of the sale were used to pay back part or all of the money your client borrowed. If this wasn't enough to pay back the loan, the broker may have also sold some or all of the stock that your client put up as collateral, in order to raise enough cash to fully pay off the loan.

* * * * *

If this sounds confusing, that's because it is. Most individual investors have no business buying anything on margin.

It doesn't really matter which stock was sold. At the end of the day, the fact is that the broker sold some stock in your client's account, in order to raise cash to pay back a loan that had become too risky.

The "feds" do not sell stock in the account of an individual investor.

The broker sells stock in order to address an individual investor's account that has become noncompliant. In other words, the account failed to comply with certain federal securities regulations that govern how much you can borrow when you put up stock as collateral to borrow money. So it could be said that the broker sold stock, without the client's authorization, pursuant to federal securities regulations. It is the broker (e.g., Merrill Lynch, Fidelity, Scottrade, etc.) who takes action. Not "the Feds."

You wrote that your client only got "about a third of the money."

The other two thirds may or may not be a capital loss on the sale of the stock.

You need to focus on the purchase price and the sale price of the stock itself--not the "two thirds of the money" that has disappeared.

What your client experienced is mathematically similar to a foreclosure.

Really. No kidding.

By way of analogy, suppose your client had a rental property that was sold at a foreclosure auction for $100,000.

Your client had an outstanding mortgage loan on the prorperty in the amount of $67,000, but he hadn't made any payments for eight months, so the bank went through foreclosure and forced the sale of the house through court proceedings.

At the foreclosure sale, some guy from Nebraska buys the house for $100,000.

The bank holding the mortgage note gets the amount that they are owed: $67,000.

Your client gets a check for $33,000 (minus all the court costs and the expenses of the sale).

So your client walks into your office and says that he made some really bad investment decisions, and it didn't work out very well, and he explains that...

"The sheriff sold my investment property to satisfy a delinquent loan, and I only got about a third of the money. Can I take the loan payoff as an investment expense?"

No, that's... not how it works.

Forget about the amount of the check that your client got when the sales transaction settled. That amount is meaningless.

Your client probably has a straightforward capital loss.

What was the sales price of the stock, and what was your client's basis?

Good luck explaining to your client that if he lost $18,000 when the stock was sold, he can only take a deduction of $3,000 a year for the next six years (unless he has other gains).

Hope this helps.

BMK

[Snaggletooth]

Maybe FDIC?

Burton, one possibility is the FDIC is having this stock sold for a large bank loan underwritten by stocks as collateral. I agree there are more circumstances we need to know than what is given in the original post.

In particular, it is almost unthinkable that the taxpayer would receive only a third of the money, unless this is a result of such a loan being paid off. In this instance, the reportable transactions would have to include the proceeds prior to the payoff.

Commissions or concomitant expenses should be allowed as a bonafide selling expense on the Sch D, but not amounts used for other purposes subsequent to the stock sales.

[JON]

I agree

with Burton. Feds selling stock?? Need more details. Obviously if he was forced to sell stock and go $70 and the margin loan was $45 he is only going to get $35. I would to her the story from jbuob. Maybe the Feds are becoming more active then even we know :-).

[Koss]

Margin Call

Reminds me of a Willy 'n' Ethel comic strip I saw many years ago...

In the first frame, Willy's nephew, a boy who is probably about 13 years old, says to Willy:

I used your name to buy something.

In the second frame, the nephew goes on to say:

There's been a margin call.

BMK