Constructive Sale Rule

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Constructive Sale Rule

A section of the Internal Revenue Code clarifying the transactions that are subject to capital gains taxation. Basically, any transaction that essentially offsets a previously held position is subject to the tax, even if it is not a straight sale of a security. An example of a transaction that falls under the Constructive Sale Rule is a short sale against the box. It is formally called Section 1259.
References in periodicals archive ?
In 1997, Congress enacted the constructive-sale rules of section 1259.
Applying the constructive sale rules of section 1259 to the implicit short sale means that Maya would be treated as having sold up to 7678 shares of ABC stock.
Unlike short sales, however, equity collars can be structured to avoid the constructive sale rules of section 1259.
112) The naked options are analyzed first because they do not implicate the constructive sale rules of section 1259.
A true short sale of ABC shares would implicate the constructive sale rules of section 1259 because Maya holds an appreciated position in 10,000 shares of ABC stock.
This interpretation is consistent with the purpose of section 1259 and with the broader principle that completed sales of property cannot be reversed in order to avoid taxable gain.
The short sale is what is interesting here, because it would cause the investor to realize gain under the constructive sale rules of section 1259.
Thus, the primary shortcoming of current law is that the constructive sale rules of section 1259 do not apply to covered calls, protective puts, and related contracts.
Schizer, Hedging Under Section 1259, 80 TAX NOTES 345 (July 20, 1998); David Weisbach, Should a Short Sale Against the Box be a Realization Event?
We believe that such caution is warranted here and recommend that, until the proposed regulatory scheme under section 1259 is developed (and taxpayers have had an opportunity to comment on the proposed rules), the IRS should issue interim guidance confirming that taxpayers may apply a reasonable, goodfaith interpretation of the constructive-sale provisions.