Short-Selling Gets Sticky at Year-End

Short-selling is a tricky business -- and this time of year the Internal Revenue Service makes it a little trickier.

Selling shares short means an investor is betting that the share price will drop. Through a broker, an investor borrows shares of a company and sells them immediately. Ideally, the share price falls and the investor can purchase the same amount at a much cheaper price. The new shares are then returned to the borrower and the investor pockets the difference. If the share price actually rises, the investor will likely be forced to pay more to buy the replacement shares, and therefore incurs a loss on his or her investment.

Because share prices can theoretically rise infinitely, short-sellers take on more risk than those who invest long (when you invest long, you can't lose more than you invest, because share prices can't fall below zero).

Short-selling isn't the evil, anti-American practice many claim it is. But frankly, if you need a definition of short-selling, you probably shouldn't do it.

Short-selling is trickier at year-end because the rules for when gains are triggered are different than the rules for when losses are triggered. Investors hoping to delay reporting a gain or accelerate reporting a loss need to be aware of these distinctions.

The rules are not new per se, but the IRS issued guidance earlier this year on when a gain or loss is triggered on short sales. "The rules were in the 1997 tax act, but little noticed at the time," says Jim Seidel, a senior tax analyst at RIA, a provider of tax information and software to tax professionals. "The IRS wanted to give the rules a higher visibility this year, though."