No Gain or Loss Needs to Be Recognized in Securities Loan Transaction for Short Sales
The Tax Court recently reiterated its position with respect to non-recognition of the loan of securities by one to another person, such as a broker or investor engaging in a short sale. The Tax Court rules that such a loan does not constitute a "sale" for which capital gains would otherwise be realized. The Court set forth the terms of the loan agreement that must be agreed to by the parties under Section 1058(b), including (1) the return to the owner of identical securities that were transferred to the borrower, (2) payments must be made to the owner of the shares equal to all interest, dividends and other distributions which the owner of the securities would otherwise be entitled to receive, if any, during the loan period, (3) the owner's risk of loss or opportunity for gain remains the same, and (4) the agreement complies with all requirements under the Tax Regulations. See Henry Samueli et al v. C.I.R., 132 T.C. No. 4 (2011).
Under the proposed regulations, the payments compensating the owner of the securities for interest, dividends and any other distributions are treated as "a fee for the temporary use of property" and not as interest or dividend income, except for those instances where the borrower defaults under the loan agreement or fails to deliver any consideration to the lender of the securities. In these limited circumstances, gain or loss must be recognized by the lender at the time of the borrower's default.
This article was written by a friend of mine, Steve Katkov. Steve Katkov is Senior Vice President and General Counsel for Commercial Partners Exchange Company (CPEC), a national qualified intermediary facilitating tax-deferred exchanges of both real and personal property pursuant to Section 1031 of the Internal Revenue Code. He has been involved in thousands of 1031 exchanges of real and personal property, including complex reverse and improvement exchanges. His client list includes Fortune 100® companies and some of the nation’s largest privately held corporations. Prior to joining CPEC, Steve served for more than six years as a Vice President/Regional Manager for First American Exchange Co. (a subsidiary of First American Title Ins. Co.).
Steve Katkov, SVP (612) 419-6118
Commercial Partners Exchange Co.
1300 U.S. Bank Plaza
220 South Sixth Street
Minneapolis, MN 55402
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