Dividends Paid on Short Sales
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By
With the market as it, many of you have decided to include shorting in your
investment strategy. It's quite possible that one of the companies that
you shorted was one that pays a cash dividend. Since you are likely
borrowing the shares that you initially sold to create your short
position, you are required to reimburse the lender of the stock for
the dividends that he missed. Your broker probably notified you
of that fact, and reduced your cash position in your account by the amount
of the dividend.
The question then becomes: Where and how do you
report this payment on your tax return? Is it an adjustment to the basis
of the stock in the short sale? Or is it a period expense that can be
deducted immediately, even if the short position was not closed in the tax
year you're filing. As with much of the tax law, there is no clear-cut
answer.
The rule
If you borrow stock to
make a short sale, you might have to remit payments to the lender in lieu
of the dividends distributed while you maintain your short position. You
can deduct these payments only if you hold the short sale open at least 46
days and you itemize your deductions.
If you close the short sale
by the 45th day after the date of the short sale, you can't deduct the
payment made to the lender in lieu of the dividend. Instead, you must
increase the cost basis of the stock used to close the short sale by that
amount.
To determine how long a short sale is kept open, don't
include any period during which you hold, have an option to buy, or are
under a contractual obligation to buy substantially identical stock or
securities. In addition, don't include any period during which you are
considered to have diminished your risk of loss from the short sale by
reason of holding one or more other positions in substantially similar or
related properties.
To deduct these expenses, they are treated as
investment interest expenses, and are subject to all of the rules and
regulations involving investment interest expense. Report these expenses
on Schedule A of your tax return. If you don't itemize your deductions
(i.e., you claim the standard deduction) investment interest expense won't
be tax-effective for you, and you'll miss this deduction. And if you can't
take the deduction because you don't itemize your deductions, it's lost
forever. There are no "elections" that you can make in order to use the
investment interest deduction to reduce any gain (or increase the loss)
when you eventually close your short position.
An
example
Let's say you short 100 shares of XYZ Company on Feb.
1 at $10 a share. On Feb. 15, your broker notifies you that your
account will be reduced by $50 for the dividend paid by XYZ Company to its
shareholders. On March 10, you close your short position by buying 100
shares of XYZ at $8 a share. Since the short position was not open for at
least 46 days, you cannot use the $50 in-lieu-of-dividend payment as a
current expense. Rather, this $50 is added to the price of the stock that
you purchased to close the position. In the example above, your net gain
on your short position would be $150
($1,000-($800+$50)=$150).
Let's use the same example, but change
the dates. Let's say that you don't close the short position until May 15.
In this case, the in-lieu payment of $50 would be treated as investment
interest, which is deductible on Schedule A (assuming that you itemize
your deductions), and your gain on the closing of the short position
would be $200.
Now, this might not make much difference during the
year, but at year-end, it might make the difference between a
current-period deduction and an adjustment to basis. So now is the time to
review your short positions and see if any will pay a dividend.
