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If a retail investor holds a short position when the stock goes ex-div, they must therefore pay a dividend to the buyer of the short. What is the tax treatment for this dividend payment the investor made? Can this be subtracted from capital gains or from income received from other dividends?

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In the USA there are two ways this situation can be treated. First, if your short position was held less than 45 days. You have to (when preparing the taxes) add the amount of dividend back to the purchase price of the stock. That's called adjusting the basis. Example: short at $10, covered at $8, but during this time stock paid a $1 dividend. It is beneficial for you to add that $1 back to $8 so your stock purchase basis is $9 and your profit is also $1. Inside software (depending what you use) there are options to click on "adjust the basis" or if not, than do it manually specifically for those shares and add a note for tax reviewer. Second option is to have that "dividednd payment in lieu paid" deducted as investment expence. But that option is only available if you hold the shorts for more than 45 days and itemize your deductions. Hope that helps!

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    The answers to taxation questions generally depend heavily on jurisdiction. How the US tax system treats this situation is unlikely to be useful. – AakashM Mar 16 '17 at 10:18
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    What @AakashM said. Notice that the question is tagged [united-kingdom], indicating that the OP is interested in answers relating to the UK specifically. As it stands, this answer may be downvoted as "not useful" for that reason. Note that you can edit your answer. – a CVn Mar 16 '17 at 10:20

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