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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{ 33 comments }

Bill August 5, 2009 at 2:06 pm

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 ?

Tax Guy August 5, 2009 at 2:25 pm

@ 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.

L Ranger March 4, 2011 at 8:28 pm

On the tax return (What line and/or Schedule) where do you claim Short Sale profit and where do you claim Short Sale losses?

Tax Guy March 5, 2011 at 10:59 am

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.

Jay Patel March 10, 2011 at 11:34 am

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

Tax Guy March 10, 2011 at 12:19 pm

Jay,
Yes. You complete Schedule 4. The losses can be carrying charges, but you really need to write in what you are claiming.

Jay Patel March 10, 2011 at 11:41 am

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?

Tax Guy March 10, 2011 at 12:01 pm

You complete a T1-Adj.

Nova Scotian March 12, 2011 at 7:00 pm

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

Tax Guy March 13, 2011 at 3:00 pm

The dividend that you paid to the lender as compensation for lending you the stock is not a deduction.

Gene G April 11, 2011 at 2:59 pm

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?

Tax Guy April 12, 2011 at 6:55 pm

You sold a share you didn’t own and received the proceeds of the sale. The form sounds right to me.

Gene G April 12, 2011 at 11:25 pm

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.

Tax Guy April 13, 2011 at 6:03 am

You report the gain on line 121. But when you bought it back.

Paul Balasch April 11, 2011 at 4:19 pm

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!!

Tax Guy April 12, 2011 at 8:48 pm

It is a securities lending arrangement that falls under s.260 of the Act. This stuff is highly complex.

Nuwan March 6, 2012 at 3:44 pm

Hi tax guy, thanks for a truly informative tax blog. I have no income from any other source in 2011 (i.e from employment etc.), but do have an overall net loss from short sales. Would that mean that I enter a negative value (i.t the loss from short sales) in my tax return? Thanks.

Tax Guy March 6, 2012 at 4:57 pm

You have a loss carryover.

No name guy March 15, 2012 at 2:31 pm

Is the loss carryover the one that can be used to apply against gains 3 years back and 20 years forward post 2005? Am I correct is interpreting that by reporting short sales losses on line 221, then one can use it to offset gains in future years or up to 3 years back? One CRA rep told me to put the short sale loss on line 135, but that seems to be for business income. I don’t know how reliable the information is from CRA staff.

No name guy March 15, 2012 at 3:07 pm

I think the confusion I am experiencing is when I look online at a booket called “Equity options tax regime” published by the TMX Montreal Exchange, it makes reference to income transactions vs. capital transactions, and talks about the murkiness of whether an option transaction belongs to an income account or capital account. But there is no clarity on where to record a definately clear income transaction such as a short sale , if it has to be recorded on Line 135 in order to have the loss carryback and loss carryover benefits.

Tax Guy March 15, 2012 at 11:23 pm

Options are different from short selling and more complex.

Tax Guy March 15, 2012 at 11:27 pm

If you’re trying to complete your tax return you should hire a pro (and not a local preparer whose fees are cheep). A proper designated accountant will take all possible deductions and deferrals.

Contact me and we talk about what you need!

Tax Guy March 15, 2012 at 11:21 pm

The gain/loss is a non capital loss and can be carried forward 20 and back 3 years. Current year losses may be reported on line 135.

No name guy March 8, 2012 at 10:41 am

Great info. Any circumstances where a dividend charge due to short sale is deductible ? I am trying to understand if I really should have been using schedule 3 for my trades in stocks, options and short sales, or should it all have been on line 135. If line 135, would it be from t2125 and a different method used ie. not using adjusted cost base. The problem if have is I do a significant number of transactions of short sales, options and equities and have been using schedule 3 for everything. Thanks

Tax Guy March 8, 2012 at 3:15 pm

No Name Guy,
The dividend is deductible in so far as you receive taxable dividends from other investments. I would suggest you contact me via the contact form at the top of the page or look me up, Burlington Accountant. I think we can save you some money and headaches!

Small Time Investor April 12, 2012 at 6:13 am

Hi Tax Guy, thanks for the blog, much appriciated for helping the “little guy” intrepret some of the tax rules. New to shorting and have a few questions:

1) For shorted securities, gains are treated as interest and recorded in Schedule 4 Part II. In this section would you itemize each security or list only the total gains by account for the tax year?

2) Likewise for losses in Schedule 4 Part IV?

3) Would you also include margin interest paid as a result of shorting securities in Schedule 4 Part IV?

4) Anyone who shorts a dividend paying security will have to cover the dividend payment. I understood these dividend payments were not tax deductable but in your reply above to No Name Guy, you imply that this may not be the case. Could you elaborate briefly?

Tax Guy April 12, 2012 at 7:42 am

I would suggest you report it on schedule 4. Keep s spreadsheet to back up your numbers and report the net amounts.

16v149 June 6, 2012 at 8:55 pm

Hello Tax Pro
Acb is the formula to calculate your long trades, to calculate the short trades what

is required . I would think its subracting your total short sells from your total short

buys. Or is necessary to itemize each short with a cover ?

New day trader

Tax Guy June 7, 2012 at 9:12 am

Each short is measured on a security by security basis. The gain or loss is the proceeds of the sale, less the cost. For partial repurchases, you can use the same ABC methodology to allocate the proceeds of sale.

16v149 June 7, 2012 at 12:52 pm

Tax Pro

Give examples to us newbies .

Thank you

Tax Guy June 14, 2012 at 5:09 pm

Hi 16v149,

Unfortunately, I see far too many day traders get themselves into serious hot water with capital gains/losses, options trading and short selling from both a trading and tax perspective. My recommendation is that if you are engaging in options trading and short-selling that you should seriously consider hiring a professional for the tax work.

Ron September 12, 2013 at 8:02 pm

If you are taxed as business income and not capital gains, do you still have to wait 30 days before buying a stock if you sold that stock at a loss.

Tax Guy - Burlington Accountant September 17, 2013 at 9:59 am

Ron,
A variation fo the superficial loss rules also applies to inventory (stocks would be inventory if trading is business income).

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