Savvy investors who feel the value of a stock will go down can use a strategy know as a short sale.
Short sales have their own unique tax profiles and anyone considering a short sale should be aware of the tax consequences.
A visitor to The Canadian Tax Resource Blog asked about how dividends were handled from a tax perspective in a short sale:
What is the tax treatment of money paid on short sales of a stock that pays a dividend? For example – stock XYZ pays a dividend of $1.50/share. If you had shorted 100 shares, what happens to the $150 that gets taken from your account? Would this be considered to be ordinary income, or would this payment be added to the adjusted cost base of the security?
What is a Short Sale?
A short sale is where an you borrow a stock from an stock broker (like Questrade) and then turn around and sell it on the stock market. The term short position indicates that you have sold something that your didn’t own and must return to the broker at some future point or if the broker demands it.
Making Money With Short Sales
If you sell a borrowed stock and the price of that stock falls, then you can buy back the stock for less than you paid for it and return it to the broker.
However, the gain, which is the difference between what you sold it for and what you repurchased it at is NOT a capital gain but is taxed just like regular income.
You can sign up and get $50 in free trades with Questrade!
The Risk Of Short Selling
If you take a short position in a stock and the price increases, you will be forced to buy back the stock for more than you paid for it. In this scenario the amount of the loss can be unlimited.
Obviously, short selling carries significantly more risk than purchasing a stock and holding it.
Income Tax and Short Selling
As mentioned above,gains and losses from short selling stocks will be treated as straight income as opposed to capital gains or losses.
The CRA has two interpretation bulletins that cover the various issues with short sales here and here.
Dividends
When you borrow stocks from your brokerage firm, the broker will not receive any dividends during the period the stock has been lent to you. Therefore, you you must then pay the brokerage firm that dividend.
Many brokerage firms simply deduct the dividend amount directly from your account during the period you have borrowed the stock. For the individual, this amount cannot be deducted from computing income.
Related Articles
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- Buy Stocks When The Market Is Down
- Claiming Losses On Bankrupt Stocks
- Selling Your Business & Saving Taxes
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{ 16 comments… read them below or add one }
What are the tax implications for a US citizen that has held a Canadian stock for four months and would now like to sell it ?
@ Bill:
I assume you are a resident of the U.S. as well and only own Canadian stocks (that is you do not live in Canada). If this is the case, any dividends you receive during the holding period will be subject to Canadian no-resident withholding tax. Any capital gains are not an issue from a Canadian perspective.
On the tax return (What line and/or Schedule) where do you claim Short Sale profit and where do you claim Short Sale losses?
You would report the net income from short selling on Schedule 4 part II, which would appear on Line 121. If you have a net loss you can report it on line 221.
Like line 121 which requires to complete Schedule 4 part II, Line 221 also requires to complete Schedule 4 part IV .
-So should it be assumed that you need to complete Schedule 4 part IV in order to report Short sale losses?
-If yes, should it go under Carrying Charges? OR under Interest Expenses? as those are the only 2 options available under Schedule 4 part IV. Thanks
Jay,
Yes. You complete Schedule 4. The losses can be carrying charges, but you really need to write in what you are claiming.
Which form & line number you would use to request an adjustment to the previously filed income tax return in which a short sale profit/loss was reported as capital gain/loss by mistake?
You complete a T1-Adj.
I had a US short stock sale loss that I paid a dividend. I am wondering if there is any place on the return that this dividend is declared/claimed. I am a Canadian citizen living in Canada
The dividend that you paid to the lender as compensation for lending you the stock is not a deduction.
I had open short position at the end of 2010. My broker issued T5008 and included total value of these sales in the “Proceed of Disposition” even though they are they don’t have a “Book value” due to I didn’t purchased them back in 2010. It seems that these transaction were incomplete and should not have been reported in 2010 tax year. What is your opinion?
You sold a share you didn’t own and received the proceeds of the sale. The form sounds right to me.
Does it mean I have to report it on Schedule 4 (Line 121) as unrealized income profit? Please advice where and how to report an open short position on Income Tax return.
Appreciate your help.
You report the gain on line 121. But when you bought it back.
Hi Tax Guy! I did some short-selling in 2010, and ‘bought to cover’ – I actually lost money on all the transactions. As well, I had to pay substantial dividends out from my brokerage account through the year. You mentioned above that paid-out dividends can not be deducted from computing income. I’ve reviewed the IT bulletins, but can not find details on where it says this …. what lines say this? I’ve phoned the CRA several times, but they couldn’t even tell me what to do with dividends that are paid out on short selling. Thanks for your help!!
It is a securities lending arrangement that falls under s.260 of the Act. This stuff is highly complex.