This article explains the new law and whether the short sale against the box has survived.
Before the TRA '97, a short sale against the box transaction generally was used to defer capital gains tax on the disposition of a long position.
Prior to the TRA '97, a taxpayer generally did not recognize immediate gain on a short sale against the box.
The character of the gain or loss realized on the July 1, 1999 sale of the long position would be long-term, because the short sale against the box was not deemed to be a constructive sale and the ABC stock had a long-term holding period when the short sale was entered into.
It is still possible to do a short sale against the box and avoid constructive sale treatment if the taxpayer meets the clearly enumerated exceptions of closing within 30 days after the end of the tax year and holding the remaining long position unhedged for 60 days.
To fully recognize the potentially negative impact of a short sale against the box after TRA '97, it is important to understand that the taxpayer can no longer use previously owned shares (i.
A short sale against the box enables an investor to eliminate the investment risk inherent in the shares of stock used in the transaction.
Under current tax law, a short sale against the box is not treated as a sale or exchange until the short sale is closed (Regs.
Whether the gain or loss recognized from a short sale against the box is capital gain or loss depends on whether the property used to close the short sale is a capital asset in the hands of the short seller.
The period for which a short seller holds the property used to close the short sale generally determines whether the capital gain or loss recognized on a short sale against the box is long-term or short-term (Regs.
As a result, under current tax law, an investor can use a short sale against the box to sell stock and defer recognition of any taxable gain inherent in that stock until the short sale is actually closed.
Further, if an investor enters into a short sale against the box and dies: before the short sale is closed, any gain inherent in the stock used to close the short sale may be completely eliminated.