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Pretty straightforward. I am up quite high on a certain stock that I believe is going to fall in the short term but continue to rise in the longer term. I would still like to attempt to make some money on this short term fall. To avoid paying short term capital gains tax on this large return (have held the stock <1 year) and to avoid the emotional anguish of selling a stock I love, I would rather not sell the shares I own. Instead, I would like to short the stock and make a profit on that short which I would be ok with paying short term capital gains on. My question is, does this make sense? Can I short a stock I am long on? Essentially I am looking to have pool A of stock X which I have bought and not sold and pool B of stock X which I have shorted and then rebought later. Can these pools remain separate? Does this even make sense?

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  • As an alternative, have you considered selingl a (covered) call? – user11599 Oct 21 '20 at 20:25
  • A covered call only provides a limited amount of downside protection unless it is deep in-the-money. However, if deep ITM then it's likely to be a non-qualified covered call and then, it suspends the holding period of the stock while the short call is open. For reference, read this. – Bob Baerker Oct 21 '20 at 22:28
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What you are considering is called Shorting Against The Box (SATB) . For the purpose of tax deferral, this was made illegal by The Taxpayer Relief Act of 1997 by adding new Section 1259 Constructive Sales Treatment For Appreciated Financial Positions. However, you are not proposing tax deferral. You are looking at the opposite direction.

You would need two brokerage accounts to execute a SATB position because brokers net out long and short positions in the same security. With a SATB, what you make on the short you lose on the long and vice versa. Therefore if your stock dropped, you would have a taxable gain on the short position with an offsetting equivalent loss on the long position. Your net gain would be zero. You would only make money if after you covered your short, share price recovered.

While short, you would pay out any dividends if you were short on the ex-dividend date. You would also pay a borrow fee which is very small on large caps (0.25% per annum) and can be very high for high beta issues (100s of percent). You'd also have bid/ask slippage and additional commissions, if you're still paying them. In the grand scheme of things, if the borrow rate is low, all of these debits are small potatoes compared to the potential savings of a successful hedge.

A fly in the ointment is that is your holding period of the substantially identical property is less than one year, your holding period is zeroed out and does not resume until the short position is closed. The holding period is not affected if you are already holding the stock long-term.

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

Also see constructive sales where a taxable capital gain is triggered if the long position has appreciated.

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  • Thank you for the in depth explanation. I have a question regarding one thing in particular, though. You note that "Therefore if your stock dropped, you would have a taxable gain on the short position with an offsetting equivalent loss on the long position". I understand the taxable gain on the short position if I cover the short once the price drops. I don't understand how they would offset, though, as I would not have sold the long position on the drop (no realized net loss), and do not plan to sell for a while after it recovers. Thus, its only a gain from covering the short, no? – Runeaway3 Oct 23 '20 at 2:39
  • It's not a loss until you sell is a rationalization that people use to negate reality. An UNREALIZED loss results from holding an asset after decrease in price, hoping that it will eventually recover. Selling the stock converts it to a REALIZED loss. Regarding margin, the amount of money a broker will lend you is dependent on the current value of the stock. Suppose you bought a $50 stock on 50% margin. When it drops below $33.33, violating the minimum margin requirement of 25%, will your broker say, "No problem mate, it was once worth $50 and there was no LOSS"? I think not. – Bob Baerker Oct 23 '20 at 3:47
  • Here's an extreme example. Do you think that anyone who bought Enron or Lehman Brothers and rode it all the way down says: "I didn't lose money because I didn't sell the stock?" Suppose you have two accounts and you're SATB (long 100 shares of XYZ in one and short 100 shares in the other). If the short has gained 20 points, the long has lost 20 points. Regardless of the price of the stock, the total value of both accounts will always be the same, regardless of the price of the stock. Making or losing money is based on today's stock price in both accounts not ignoring one of them. – Bob Baerker Oct 23 '20 at 3:47
  • The point I am making specifically refers to the "taxable gain" on the covering the short and the "offsetting equivalent loss" on the long. As it pertains to taxes, it is only the realized gain. The unrealized loss from the long position does not net the taxable gain to 0. Is my understanding here correct? – Runeaway3 Oct 23 '20 at 4:05
  • After going Short Against The Box, the gain or loss is zero until you close the short position. Once closed, you have a tax debt and therefore it is technically a negative return. However, it's a tax debt not a payment until taxes are due so you can argue details any which way you want. The big picture answer is that if you are Short Against The Box, the two positions offset until unwound. – Bob Baerker Oct 23 '20 at 11:15

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