Unfortunately, short sales against the box
now are treated for income tax purposes as constructive sales, making them much less attractive for hedging purposes.
Even though this is still possible, from an economic perspective, short sales against the box
designed to avoid constructive sale treatment have now become risky transactions.
The first part explains the principal financial instruments affected by section 1259: short sales against the box and total return equity swaps.
To understand short sales against the box, familiarity with the practice of short selling is necessary.
29) A more salient point with respect to this Note is the fact that the proceeds from short sales against the box cannot be used by the average short seller.
Although referred to as short sales against the box legislation,(47) section 1259 reaches beyond this one financial instrument and also affects certain derivative instruments.
53) Similar to short sales against the box, the motivations to enter into swap arrangements include speculation, hedging, and tax advantages.
88) With respect to open transactions such as short sales against the box, a taxpayer did not realize capital gain or loss until the taxpayer returned the borrowed stock and closed the short position.
If this proposed legislation is enacted, the use of short sales against the box as an income tax planning technique would end.
To prevent taxpayers from eliminating the economic risk of loss and the opportunity for gain in appreciated property without recognizing taxable gain, and in order to more clearly reflect income from the sale of stock or other securities, President Clinton's proposed fiscal 1997 budget includes two revenue provisions addressing short sales against the box.
Consequently, this proposal would eliminate taxpayers' ability to avoid immediate recognition of gain through short sales against the box.
Although it is impossible to predict at this time whether either proposal will be enacted and, if enacted, in what form, the attention being focused on short sales against the box (and other similar hedging techniques) as an income tax deferral or avoidance device may eventually result in legislation eliminating the tax benefits currently associated with short sales against the box.