Sophisticated investors such as you may engage in securities transactions that are far more complex than the typical simple stock purchase or sale. As investments and investment strategies have become more complex, Congress has developed equally complex tax rules to govern them. One such rule is the constructive sale rule. The constructive sale rule addresses certain types of transactions involving stocks, securities, and other financial instruments – such as a short sale against the box – that have the effect of allowing the investor to enjoy the benefits of the appreciation in these assets without actually having sold them.
You are treated as having made a constructive sale when you enter into a covered transaction involving appreciated financial positions in stock, partnership interests, or certain debt instruments. As a result, you must recognize gain as if you disposed of the position at its fair market value on the date of the constructive sale. This also gives you a new holding period for the position that begins on the date of the constructive sale. Then, when you close the transaction, you reduce your gain (or increase your loss) by the gain you recognized on the constructive sale.
For this purpose, an appreciated financial position is any interest in stock, a partnership interest, or a debt instrument (including a futures or forward contract, a short sale, or an option) if disposing of the interest would result in a gain. However, it does not include:
(1) any position from which all of the appreciation is accounted for under marked-to-market rules;
(2) any position in a debt instrument if (a) the position unconditionally entitles the holder to receive a specified principal amount, (b) the interest payments (or other similar amounts) with respect to the position are payable at a fixed rate or a variable rate described in IRS regulations, and (c) the position is not convertible, either directly or indirectly, into stock of the issuer (or any related person); or
(3) any hedge with respect to a position described in (2) above.
An interest in an actively traded trust is treated as stock unless substantially all the value of the property held by the trust is debt that qualifies for the exception to the definition of an appreciated financial position described in (2) above.
You are treated as having made a constructive sale of an appreciated financial position if you
- enter into a short sale of the same or substantially identical property,
- enter into an offsetting notional principal contract relating to the same or substantially identical property,
- enter into a futures or forward contract to deliver the same or substantially identical property (including a forward contract that provides for cash settlement), o
- acquire the same or substantially identical property (if the appreciated financial position is a short sale, an offsetting notional principal contract, or a futures or forward contract). You are also treated as having made a constructive sale if a person related to you enters into a covered transaction with a view toward avoiding the constructive sale treatment.
You are not treated as having made a constructive sale solely because you entered into a contract for sale of any stock, debt instrument, or partnership interest that is not a marketable security if it settles within one year of the date you enter into it. Also, a transaction is not treated as a constructive sale if:
- you closed the transaction on or before the 30th day after the end of your tax year,
- you held the appreciated financial position throughout the 60-day period beginning on the date you closed the transaction, and(3)
- your risk of loss was not reduced at any time during that 60-day period by holding certain other positions.
Other special rules that may come into play include the rules governing related party transactions, wash sales, short sale, conversion transactions, straddles, constructive ownership, and Section 1256 contracts. Please call me at your convenience to discuss how any of these rules may affect the tax treatment of your investment transactions.
Please contact the office of Don Fitch Accountancy at (760)567-3110 or Email Don.Fitch@CPA.com if you have any questions or would like additional information.
DON FITCH, CPA
74478 Highway 111 #3
Palm Desert, CA 92260
Toll Free: (877)CPA-Help or (877)272-4357
P.S. My firm is based upon referrals. Please feel free to refer my firm to anyone you know that is looking for a new CPA and/or tax preparer. Thank you in advance.
(Updated 05012021-1 320-305)