[IMGCAP(1)]It’s the time of year when investors examine their portfolio and seek to harvest built-in tax losses. But short sellers who wish to harvest their losses should keep a close eye on the calendar.
“Investors looking to sell securities by year end should be aware of the trade date rules,” according to John Kaufmann, of counsel at Greenberg Traurig and a leading authority on the tax aspects of financial instruments.
The trade date rule governs whether the gain or loss from the disposition of a security is taken into account on the trade date – when the seller clicks “sell” or the buyer clicks “buy” – or on the settlement date. For securities traded on U.S. equity exchanges, the settlement date is usually three business days after the trade date, while for bonds, the settlement date is usually one business day after the trade date, explained Kaufmann. Although gain or loss is locked in as of the trade date, the transaction does not close until the settlement date.
While money and property do not exchange hands immediately when you click “buy” or “sell,” the Internal Revenue Service has taken the position that for regular trades placed on an exchange, the securities are treated as being disposed of and a gain or loss is recognized on the trade date, rather than the settlement date.
However, that general rule does not apply to short sales, warned Kaufmann. “Since a short seller’s obligation to deliver shares to a securities lender is not extinguished until the shares are actually delivered, a short position is not closed until the settlement date of the covering trade,” he said. “This means that in contrast to the treatment of long sales, gain or loss from a short sale is generally not recognized until the settlement date.”
Congress changed the rule in 1997 and, as a result, a gain on a short sale is recognized on the trade date, whereas a loss on a short sale is recognized on the settlement date, explained Kaufmann. With January 1 quickly approaching, he cautioned, it behooves investors with short positions seeking to harvest a loss to watch the calendar closely.
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