Short Against the Box

[Snaggletooth]

Some investors engage in transactions called "Selling Short Against the Box". For all practical purposes, the effect is that the investor actually sells stock before he buys it. The objective is to deliver a profit to an investor who is confident the stock will fall in price and thus he can buy cheaper.

Yes, this actually DOES happen, in spite of the heuristic impossibility. Of course the broker has various deposits/committments, etc. to insure against all manner of wierd results.

My question is how our software deals with this. I haven't had to report such a thing but will have to do so in 2011. Will the software intercept a sale dated prior to the buy and give us a hard edit? How do such transactions appear on a 1099-B?

[Gene V]

Some investors engage in transactions called "Selling Short Against the Box". For all practical purposes, the effect is that the investor actually sells stock before he buys it. The objective is to deliver a profit to an investor who is confident the stock will fall in price and thus he can buy cheaper.

Yes, this actually DOES happen, in spite of the heuristic impossibility. Of course the broker has various deposits/committments, etc. to insure against all manner of wierd results.

My question is how our software deals with this. I haven't had to report such a thing but will have to do so in 2011. Will the software intercept a sale dated prior to the buy and give us a hard edit? How do such transactions appear on a 1099-B?

Snaggletooth,

My software will accept reverse dates on short sales; it also has a place to check for “Open Short Sale”
D-4 of the instruction tells how to report “Open Short Sale”
I did quite a few short sales in 2008, before I lost all of money.

[David1980]

Some investors engage in transactions called "Selling Short Against the Box". For all practical purposes, the effect is that the investor actually sells stock before he buys it. The objective is to deliver a profit to an investor who is confident the stock will fall in price and thus he can buy cheaper.

Yes, this actually DOES happen, in spite of the heuristic impossibility. Of course the broker has various deposits/committments, etc. to insure against all manner of wierd results.

My question is how our software deals with this. I haven't had to report such a thing but will have to do so in 2011. Will the software intercept a sale dated prior to the buy and give us a hard edit? How do such transactions appear on a 1099-B?

It's not quite impossible, as what ends up happening is the broker "borrows" stock from one person to sell for the short sale. Then when they buy the stock, they return it to the lending party. A lot of brokers have it in their fine print somewhere that your stocks can be borrowed for this purpose. If it's a dividend issuing stock, the borrower has to pay the dividends.

Hence one purpose for "substitute payments in lieu of dividends or interest", or box 8 of 1099-MISC.

[Gary2]

I don't think the 1099-B proper (pre 2011) will have any indication that it was a short sale. You discover it when trying to get the purchase date.

Most, if not all, year-end brokerage statements included with the 1099-B will have it marked as an open short sale if that's the case. If closed in the same year, it may or may not mark is as short, but you can infer that from the buy and sell dates.

[taxxcpa]

Short against the box

Shorting against the box is some kind of gimmick that involves shorting stocks you actually own, but treating it as a short sale to be covered later.
An ordinary short sale is the sale of stock that you do NOT own, but will purchase later, hopefully at a lower price, to cover the short position.

I'm not sure how an open short sale is handled on a tax return, but there would be no taxable gain or loss until the short sale is covered.

[Snaggletooth]

Timing

Thanks for all the discussion and pointers. Taxxcpa brings up an unusual circumstance if no taxation until short sale is covered.

Imagine a "sale" dated Dec 28th. "Purchase" is not made until Jan 3rd. I will accept from Taxxcpa that taxation does not occur until Jan 3rd. However, if a 1099-B lists all sales, will it list the Dec 28th sale as needing to be reported?

[David1980]

Here's what the Sch D instructions indicate:

If you received a Form 1099-B for a short sale you entered into in 2010 but that did ont close in 2010, report it on line 1 or line 8. Enter the sales price in column (d). If the short sale did not close in 2010, enter "Open Short Sale" in colun (e) and -0- in column (f). When the short sale is closed in a later year, report any gain or loss on your return for that year.

So you report this "open short sale" for the dec 28th sale (assuming a 1099-B is received) but no gain/loss until the following tax year (since the sale is still open until Jan 3rd.)

[Gary2]

Shorting against the box is some kind of gimmick that involves shorting stocks you actually own...

I wasn't familiar with the jargon, but tax-wise, this is a different situation that can result in a constructive sale. In other words, you can't lock in a profit while deferring the taxes by making a short sale of stock you already own. In the simple case, it's treated as if the short sale were really a sale of the stock that was already owned. If new stock is subsequently purchased to close the short, the holding period for the new stock starts on the date of the short sale.

It can often be more complicated, so read Pub. 550 carefully and research it.

[FEDUKE404]

Explanation of SAB

Shorting against the box is some kind of gimmick that involves shorting stocks you actually own, but treating it as a short sale to be covered later.
An ordinary short sale is the sale of stock that you do NOT own, but will purchase later, hopefully at a lower price, to cover the short position.

I'm not sure how an open short sale is handled on a tax return, but there would be no taxable gain or loss until the short sale is covered.

This is my understanding as well, namely that there IS a difference between a "regular" short sale versus shorting against the box.

Years ago my stockbroker suggested this option in order to "move" a gain into the next calendar year. The only drawback is your sale price is established once the action is taken, meaning should the stock rise in value (think buy out) your own sale price would not benefit.

Since Form 1099-B was not around then, I forget exactly how it was reported/handled.

Here is a good summary of the underlying strategy:

http://www.schwab.com/public/schwab/research_strategies/market_insight/investing_strategies/portfolio_planning/strategies_for_hedging_and_diversification.html

FE

[DonPriebe]

Short against the (stocks in your safety deposit) box

From http://www.allbusiness.com/legal/laws/247942-1.html

Prior to the enactment of the Taxpayer Relief Act of 1997 (TRA '97), a taxpayer could hedge against volatility in the value of stock by completing a "short sale against the box," which had no tax consequences until the taxpayer closed the position by returning borrowed shares to the lender. The TRA '97 curtailed use of this technique by deeming the short sale a constructive sale on which gain or loss must be immediately recognized (whether or not the position is sold). This article explains the new law and whether the short sale against the box has survived.

[Golden Rocket]

"Constructive" Gain??

The TRA '97 curtailed use of this technique by deeming the short sale a constructive sale on which gain or loss must be immediately recognized (whether or not the position is sold).

Don, this appears to be at odds with Taxxcpa and David80 above, upon whose reliance one would not report the gain/loss until the transaction was closed. Are we talking about the same kind of transaction??

[JON]

I am with Don

Short against the box established a transaction in the current year and it was reported in the following year. The only time I have done it was in the early 90s and the broker offerred it. I think it could only be done a few days before the new year and could only be done by some float the broker would offer. I remember asking the the broker and he said the opportunity comes up at the year end once and a while.

Short sale can happen any time and the cover can be flexible..

[David1980]

Don, this appears to be at odds with Taxxcpa and David80 above, upon whose reliance one would not report the gain/loss until the transaction was closed. Are we talking about the same kind of transaction??

What I posted was about short sales, but it's possible a "short sale against the box" doesn't qualify as a short sale. In which case, it would just be a sale. So, I don't know?

[Gary2]

Don, this appears to be at odds with Taxxcpa and David80 above, upon whose reliance one would not report the gain/loss until the transaction was closed. Are we talking about the same kind of transaction??

Part of the confusion is because the base note uses the phrase "short against the box" but then goes on to describe an ordinary short sale, where the investor doesn't already own the stock.

An ordinary short sale is as David1980 described: If open at the end of the year, report it on schedule D as open, and then report it again when it's actually closed.

But if it's a short against the box, i.e., the investor already owned the stock before executing the short sale, the constructive sale rules come into play. As Don and FE indicated, this didn't used to be the case. Once upon a time, it was legal to defer the gains into the next year by shorting against the box, with little risk. Even now, there are still special cases where the investor isn't forced into the constructive sale.

[Snaggletooth]

Thanks

Thanks Gary 2. I think this was the clarification all of us were looking for.