Question

Investor owns 1,000,000 shares of stock of Corp. XYZ with a zero basis and a FMV of 100,000,000 that the investor has held for 20 years. The investor sells 1,000,000 shares of XYZ short for $100,000,000 in February 2016. On January 29, 2017, the investor purchases 1,000,000 shares with normal settlement for $120,000,000 and instructs the broker to deliver those shares to close the short sale. What are the tax consequences in 2016 and 2017?

Answer 1

For 2015, tax consequences will be on the amount Investor has received by shorting the share i.e. $100,000,000. Depending on his tax bracket, taxes will be applicable.

For 2016, the Investor closes the short and buy the shares from the market. He had faced a loss on the transaction, as the share price has increased because he has paid more amount to buy it back than he had expected.

$120mn to buy and $100mn to short => $20mn loss for the investor. This can be offset against the gains the investor may have in the rest of 2016 and accordingly taxes will vary.

Since the dividends belong to the lender of the stock, the investor will not have to pay taxes on the dividends received. Even if he pays taxes, he can reclaim it from the lender as the dividends belongs to the lender.