Reporting most investment income is pretty straightforward. Calculate the gain or loss and enter it on Schedule D. The only trick is whether to report as a long-term or short-term capital gains or capital losses.
With short sales, however, there are a couple of tax tricks to know about how they get reported.
Long-Term or Short-Term Short Sales
The most important thing to understand about short sales, is that they are almost always considered short-term capital gains or losses.
Unlike a traditional investment where you buy and hold the property, with a short sell, you do not own the property at all. You borrow the shares from your brokerage who gives you the proceeds of the sale. You close the sale by buying back the same shares you sold.
It may seem like you determine whether a short sale is long or short-term by the amount of time that passes in between when the short sale is initiated and when it is closed. However, this is not the case.
In order to be a long-term capital gain, you have to OWN the property in question for more than one year. With a short sale, you never own the property. Or, if you prefer, you own the shares for a few seconds between when you execute the buy order and the brokerage takes those shares to repay the loaned shares. In other words, all short sales are short-term capital gains or short-term capital losses.
Long-Term Short Sale Exception
There is a way to have a long-term short sale, although it is not very common. If you don’t do it intentionally, it won’t happen.
Consider an investor who owns 1,000 shares of IBM stock. The investor chooses to sell 1,000 shares of IBM short instead of selling their current holdings. Some brokerages won’t allow this, but it is easy enough to execute via two brokerages.
If you have already owned the IBM stock in question for a period of more than one year, and if, and only if, you use those previously owned shares to close the short sale position, then the short sale may be reported as a long-term capital gain or loss.
However, this will be considered a “constructive sale” and you will have to report the gain as of the date of the short sale and your basis resets.
There is no way for a short sale to be a long-term investment unless you already own what you are selling short.
All of this, of course, assumes that you have not trigged the rules for wash sales.
Reporting Short Sales on Schedule D
Like other investment gains and losses, gains and losses from short sales are reported on Schedule D.
Enter the data from the short sale in the same manner as a regular trade. However, pay attention to what the columns say so that you get the income taxes right.
Column C is the date sold, this is the date you started the short sale, not the day it closed. Column A is when you “acquired” or bought the shares to close the position. Likewise, the Sales Price (Column D) is what you received when you sold short, and Cost Basis is what you paid to close the short.
There is no need to specially mark a short sale. You are the first person to sell a stock short and the IRS is well aware that if the Date Sold precedes the Date Acquired that you have engaged in a short sale. As long as you enter the right numbers in the right columns, all of the math on the form works out the same.