What are tax implications of being long and short stock at the same time?

Question

Let's assume that I am expecting a dip in a stock that I own. In such cases the usual strategy is to sell stock and buy back at a later date during the dip. However, this would trigger a taxable event and

1. reset my entry date that would have helped me to qualify for long term capital gains; AND
2. I would deleverage my position by paying taxes to IRS early (i.e. if I wanted to reenter later at the same price then I would be able to buy less shares compared to when I did not sell anything)

Instead, could I simply short the stock while still maintaining my long position and cover the short on the dip? This seems like a better strategy unless I am missing some tax rules?

Answer 1

Entering a short position that offsets an existing long position is called shorting against the box. Since 1997, the US tax code has considered this as a constructive sale of the long position, triggering a taxable capital gain if the long position has appreciated.

The purpose of the constructive sale rule is to prevent investors from locking in investment gains without paying capital gains and to limit their ability to transfer gains from one tax period to another.

Answer 2

To avoid a constructive-sale, hold the long position for at least 60 days after the close of the short position and don't carry the short position more than 30 days past the end of the year.

https://wealthstrategiesjournal.com/2016/10/21/ted-dougherty-and-lisa-sergi-tax-planning-using-the-constructive-sale-rules-when-is-a-constructive-sale-not-a-constructive-sale/

Or use a put option to hedge the position.

Answer 3

Yes, you are missing some tax rules.

Many decades ago when owners held their shares in certificate form, they stored them in their safe deposit boxes. If they shorted a security in their brokerage account in order to defer taxes, it became known as Shorting Against the Box.

The Taxpayer Relief Act of 1997 virtually ended this tax deferral strategy by adding new Section 1259 Constructive Sales Treatment For Appreciated Financial Positions (there is an exception but it is not applicable to your example).

In addition, the holding period resets (see the example about Baker Company at the bottom of page 55 in iRS Pub 550).

Last of all, if the shorted stock has a dividend and you are short on the ex-dividend date, you may also have some tax issues related to the deductibility of the dividends paid out.

Answer 4

Your investments don't generate taxable events in the USA until you either generate a profit or a loss. Until that point, the IRS doesn't care how you structure your investments.

The other way to do what you want to do would be what the IRS calls a "wash sale". In this, you sell the stock in one year to take the loss and apply that to your tax basis. Then the next year you buy back the same stocks. The IRS has very specific rules about this. Mainly around how much time elapsed between the sale of the stocks for the loss and the repurchase. If it is not done "just right" there could be tax penalties.

Consult a tax CPA or attorney for the correct way of doing what you plan.