Short Sell Against the Box

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Short Sell Against the Box

Describing the action of short selling a security one owns. When one sells against the box, gains and losses are equalized by the long position on a security combined with the short position created by the short sale. One formerly sold against the box generally in order to be able to claim profits on the sale in the following tax year, but the Taxpayer Relief Act of 1997 largely removed this loophole.
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An investor that had an appreciated position that he wanted to sell but didn't want to incur a taxable gain for could enter into a short sale against the box. This allowed the investor to perfectly hedge and thus completely avoid any further price changes (equivalent to the situation if the position had been sold outright and the investor simply no longer owned the security) without requiring the investor to declare the taxable gain (because the position was still open).
Prior to the enactment of the Taxpayer Relief Act of 1997 (TRA '97), a taxpayer could hedge against volatility in the value of stock by completing a "short sale against the box," which had no tax consequences until the taxpayer closed the position by returning borrowed shares to the lender.
In a "short sale against the box," a taxpayer owns a long position and borrows an equal amount of stock from his broker to sell.
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 gain on the borrowed and sold shares was not recognized until the taxpayer closed the sale by returning identical property to the lender.
Gluttonous investors should heed its advice because Congress, through its enactment of the Taxpayer Relief Act of 1997,(2) has taken aim at the tax benefits once reaped by engaging in short sale against the box transactions.(3) Investors no longer will be able to enter into absolute hedges without recognition of capital gain; rather, they will be forced to recognize capital gain on appreciated financial positions even if those positions are not sold.
Fundamentally, section 1259 does not address directly the true abusive practices involved in the Lauder transaction--the ability to sell short against the box indefinitely without any possibility of being squeezed;(17) the opportunity to obtain the proceeds from the short sale against the box before the transaction is closed;(18) and, finally, the combination of Revenue Ruling 72-478(19) and section 1014 of the Internal Revenue Code ("the Code").(20) Rather, section 1259 creates an inequitable standard that is both contrary to longstanding tax doctrine and detrimental to legitimate investment decisions.
A short sale against the box is mechanically identical to a plain short sale with one important exception.
The result was a perpetual short sale against the box. Although the Administration sought to tax such a transaction up front,(118) section 1259 does nothing directly to discourage or prevent this inequity.
A "short sale against the box" occurs when a shareholder owns a particular stock and enters into a short sale with respect to borrowed shares of the same stock.
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.