Income Tax and Short Selling Stocks

by Tax Guy - Burlington Accountant on October 6, 2011 Print This Post Print This Post

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

Questrade Democratic Pricing - 1 cent per share, $4.95 min / $9.95 maxWhen 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, but may be deducted to the extend you have other dividend income.

About The Tax Guy...

Dean Paley CGA CFP is a Burlington accountant and financial planner who services individuals and business owners locally, nationally and internationally. Dean has appeared in the National Post, Toronto Star and Metro News.

To find out more, visit Dean's website Dean Paley CGA CFP or connect via Twitter @DeanPaleyCGACFP.

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