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Tax Analysis of Securities Transactions
May 30, 2015
Wash Sales, Constructive Sales
and Straddles: A Primer
William Fang
Senior Software Engineer
and Senior Business Analyst
Daniel Tilkin
Software Engineering Team Lead
and Senior Tax Analyst
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Course Description and
Learning Objectives
In this course, you will learn the basics of tax
analysis of securities transactions (TAST). After
this course, you will be able to:
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Define the following taxable events: basic wash sales, constructive sales
and straddles.
Differentiate between chaining and branching.
Apply the concept of "substantially identical securities" to wash sales and
constructive sales.
Identify which specific short sales trigger constructive sales.
Interweave cost basis adjustments across different rules in the tax code.
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Presenter and Reviewer Bios
Presenter:
William Fang, Software Engineer and Senior Business
Analyst, G2 FinTech
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Mr. Fang focuses on securities transactions and tax accounting at G2. He co-writes white
papers on bond amortization, cost basis reporting and other complex tax issues. Mr. Fang
speaks at tax conferences where he shares his knowledge of tax analysis / accounting of
investment portfolios.
Presenter:
Daniel Tilkin, Software Engineering Team Lead and
Senior Business Analyst, G2 FinTech

Mr. Tilkin is an expert on tax accounting and securities transactions. He co-writes white
papers on wash sales, constructive sales, tax straddles and other sections of the Internal
Revenue Code (IRC). Mr. Tilkin also speaks at tax conferences where he shares his tax
accounting expertise.
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Presenter and Reviewer Bios
Reviewer:
C. Dan Stubbs, CPA
C. Daniel Stubbs, Jr., CPA, Clinical Assistant Professor and Director, Master of
Accountancy in Financial Accounting, Rutgers Business School. Mr. Stubbs is a former
member of the Executive Committee of the NYSSCPA Board of Directors and past
Executive Secretary of the NY State Board for Public Accountancy.
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Introduction
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People engage in activity that economically benefits them.
Almost all people are taxpayers and taxes do not benefit
taxpayers.
People will engage in activity that may seem superfluous but
in reality confers upon them tax advantages.
For example, sell a stock for a loss on 12/31 but sell a stock
for a gain on 1/1.
Congress has written rules to prevent some of these taxoptimization behaviors.
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Overview
Basic Tax Rules
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Wash Sales
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A Wash sale occurs when a taxpayer disposes of
a position at a loss and presently enters a new
position that is economically similar.
Constructive Sales
Straddles
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Wash Sales Rules
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Wash Sale – sale where loss is realized and where
substantially identical property is acquired, or a contract or
option to acquire (e.g. forwards and call option) substantially
identical property is entered into with a 61-day window
beginning 30 days prior and ending 30 days following the sale
date.
Losses are disallowed and added back to basis of new security
acquired – essentially usually deferred until new security is
sold.
Goal of Rule – prevent loss harvesting by taxpayer where
position remains essentially unchanged.
Rule only applies to losses not to gains.
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Wash Sales Examples
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A Simple Wash Sale
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01/01/10 Buy 100 shares MSFT for $100/share.
12/30/10 Sell 100 shares $50/share – realize loss of $50/share.
12/31/10 Buy new 100 shares MSFT for $49/share.
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The basis of the 12/31 Buy is $99/share
A Backwards Wash Sale
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01/01/10 Buy 100 shares AAPL for $100/share.
12/30/10 Buy 100 more shares AAPL for $50/share.
12/31/10 Sell original 100 shares for $49/share – realize loss of
$51/share.
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The basis of the 12/30 Buy is $101/share
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Wash Sales
Branching and Chaining
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Chaining: When the cost basis adjustment to the
replacement position in a wash sale affects the
disallowed loss on a later wash sale.
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Example: On successive days, buy 1 share for $100, sell for $89, buy
for $88, sell for $90, buy for $93 -> Final basis $102
Branching: When the size of the replacement
position is larger or smaller than the original
position.
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Example: On successive days, buy 3 shares for $100, sell 3 shares for
$89, buy 1 share for $88 -> $22 loss recognized, $11 disallowed
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Wash Sales
Substantially Identical
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Substantially Identical – The Revenue Act of 1921 envisioned potential loopholes
with the wash sale rule and hence introduced “the elastic weasel word”
substantially identical to the code.
The term has no definition and it has been left to the courts and the IRS to
determine what is and is not SI.
In Hanlin v. Commissioner, the appellate court introduced the concept of feature
comparison in the determination of SI.
 Stock vs. Stock
 Voting rights, Common vs. Preferred, Dividend Rights
 Bonds vs. Bonds
 Issuer, Interest Rate & Yield, Maturity, Call Provisions, Tax Provisions,
Investor Limitations
 Options vs. Options
 Expiration Date, Delta and other Greeks, Strike Price, Put/Call,
American/European, Risk Factors
Others
 Deep-in-the-Money Puts
 Convertibles
 Warrants may be substantially similar to stock
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Wash Sales
Options and Contracts to Acquire
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Introduced later (post 1921).
Call options will always trigger wash sale when stock is sold at a loss and a
call on the stock is purchased.
Rights, Warrants, and often Convertible securities are all considered
options for this purpose.
Options wash sales generally work one way – sell stock, acquire option.
 Selling option at a loss and acquiring stock is generally OK.
 But be careful where options are deep in the money (delta near 1, and
values substantially similar) – may be considered to be the equivalent
of stock (56-406 – Warrants).
All of the above rules also apply when the option’s underlier is
substantially identical to the original security.
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Wash Sales
Application To Short Sales
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Short Sales – corollary rules apply for losses
recognized on closing short sales.
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Generally apply the reciprocal to normal wash sale rules
that apply to losses on longs.
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Rule on shorts are not 100% clear but generally
practitioners expect the courts to apply the rule to shorts
in a similar manner as it is applied to longs.
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Example: Close a short at a loss and buy a put -> likely a wash sale
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Overview
Basic Tax Rules
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Wash Sales
Constructive Sales
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A Constructive Sale occurs when a taxpayer holds an
“appreciated” position in a security, and acquires an
“opposite” position in the same or substantially identical
security.
Straddles
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Constructive Sales Rules
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Treated as if the original position were actually sold.
 Recognizes gain only.
 Does not apply to losses.
 End old holding period and start new holding period as of constructive
sale date for original position. Therefore when you sell the original
position, the date of the constructive sale is deemed to be the date on
which the position was acquired.
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Applies to Appreciated Financial Positions where taxpayer:
 enters into a short sale of the same or substantially identical property,
 Or enters into an offsetting notional principal contract with respect to
the same or substantially identical property,
 Or enters into a futures or forward contract to deliver the same or
substantially identical property.
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Constructive Sales Rules
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Applies to short positions also.
 in the case of an appreciated financial position that is a short sale or
similar contract from the previous slide with respect to any property,
acquires the same or substantially identical property, or
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To the extent prescribed by the Secretary in regulations, applies to
taxpayer who enters into one or more other transactions (or acquires one
or more positions) that have substantially the same effect as a transaction
described in any of the preceding subparagraphs.
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Non-Convertible Debt Instruments are exempt from the Constructive
Sales Rule
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Constructive Sales Example
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Basic Constructive Sale
 01/01/10 Buy 100 shares MSFT for
$100/share.
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12/30/10 Sell short 100 shares for
$1000/share – lock in gain of
$900/per share ($90,000 total).
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Constructive Sales
Exception Rules
No constructive sale if:
Hedge is closed on or before the 30th day after the close of taxable year (typically
January 30th of the following year),
And the taxpayer continues to hold the appreciated financial position throughout a
60-day period beginning on the date such transaction is closed,
And the position remains ‘un-hedged’ for the duration of this period.
 A hedge may be disregarded if the disposition of the hedge in turn obeys the
three above rules.
Example
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01/01/97 Buy AAPL for $50/share.
01/01/03 Short AAPL for $100/share.
10/30/03 Cover the short on 10/30/03.
No further activity on AAPL in 2003 or 2004
Thus, this safe harbor allows taxpayers at least one year of tax deferral in exchange
for 60 days of complete exposure. With a string of total-return hedges, the taxpayer
can be fully hedged indefinitely for 10 months each year.
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Overview
Basic Tax Rules
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Wash Sales
Constructive Sales
Straddles
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A Straddle occurs when a taxpayer holds two offsetting
positions simultaneously.
Losses may be disallowed when the taxpayer disposes of
one of them at a loss while holding the other until the
end of the tax year.
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Straddles Rules
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Goal – Avoid taxpayers being able to mechanically generate losses using two positions
moving in opposite directions where one economically hedges the other.
 Also affects holding periods of affected positions.
 Specifically prevents taxpayer from converting LT Capital losses to ST capital
losses
A taxpayer holds offsetting positions with respect to personal property if there is a
substantial diminution of the taxpayer’s risk of loss from holding any position with
respect to personal property by reason of his holding 1 or more other positions with
respect to personal property (whether or not of the same kind).
Common Examples:
 Long Stock – Short Call*
 Long Call – Long Put
 Long Stock – Long Put
 Long Call – Short Call
 Long Put – Short Put
* Exception for Qualified Covered Calls
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Straddles Consequences
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Loss Deferral – defers losses to the extent of unrealized gains. Loss not in
excess of gain is treated as occurring in the following year, subject to meeting
the same straddle rules in that year.
 Unrealized gain is the amount of gain at the end of the year – not amount
of gain at time straddle is removed.
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Holding Period – resets holding period of certain property that has not been
held for LT holding period at start of straddle.
 If a loss is ultimately recognized and the property had been held for the
long-term holding period at start of the straddle, the holding period will
not be reset and the loss will be long term.
 Prevents using rules offensively to convert LT losses to ST losses.
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Carrying Costs must be capitalized
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Straddles Examples
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Total Loss Example
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01/01/10 Buy 100 shares MSFT for $100 /share
10/01/10 MSFT at $150/share. Hedge by buying 150 strike put on 100 shares for
$10 – lock in gain by having right to sell at $150/share.
12/21/10 MSF T at $160/share. Put expires worthless. Realize $10 loss on put.
12/31/10 MSFT is still trading at $160/share.
Limited Loss Example
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01/01/10 Buy 100 shares AAPL for $100/share.
10/01/10 AAPL at $150 /share. Hedge by buying 150 put on 100 shares for $10 –
lock in gain by having right to sell at $150 per share.
12/21/10 AAPL at $160/share. Put expires worthless. Realize $10 loss on put
for a total of $1000.
12/31/10 AAPL at $102/share.
Unrealized gain of $2/share ($200 total), so the 2010 loss is reduced to $800 from
$1000.
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Straddles – QCCs
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Qualified Covered Calls – written calls that are not considered
straddles.
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Loss is not disallowed
Holding Period – Not reset. Suspended if call is written inthe-money. No effect if out-of-the money or at-themoney. May also force loss on option to long-term.
Carrying Costs – Not capitalized.
Exception: If you close one side at a loss near the end of
year, and close the other side at a gain within 30 days and
in the following year, qualified covered call is disallowed.
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Straddles – QCC Requirements
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Traded on a national securities exchange or qualifying OTC
option.
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Granted more than 30 days and not more than 33 months
before the day on which the option expires.
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Not a deep-in-the-money option.
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Not granted by an options dealer.
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Gain or loss with respect to such option is not ordinary
income or loss.
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Straddles – QCC Requirements
Deep In The Money
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Applicable Stock Price Concept
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Prior day’s closing price (or current day’s opening price if stock opened up more than 10%).
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Not based on current price.
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Options extending out more than a year are subjected to an adjustment factor/multiplier.
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Deep In The Money – Generally below the highest available strike price which is less than the applicable stock
price.
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Special Rules:
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90+ Day Options
 granted more than 90 days before the date on which such option expires, and
 with respect to which the strike price is more than $50,
Lowest qualified bench mark is the second highest available strike price which is less than the applicable
stock price.
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85 percent rule
 the applicable stock price is $25 or less, and
 but for this clause, the lowest qualified bench mark would be less than 85 percent of the applicable
stock price,
Lowest qualified bench mark shall be treated as equal to 85 percent of the applicable stock price.
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$10 Limitation
 the applicable stock price is $150 or less, and
 but for this clause, the lowest qualified bench mark would be less than the applicable stock price
reduced by $10,
Lowest qualified bench mark shall be treated as equal to the applicable stock price reduced by $10.
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Interweaving
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All the above topics can affect one another and proper
production of tax books requires the practitioner to consider
these interactions.
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Example 1: A wash sale adjusts the cost basis of a position. That position therefore
carries an unrecognized taxable loss although its economic gain may be positive. Should
that position appear to be involved in a constructive sale, it may be the case that no CS
in fact actually occurred since the lot must be carrying an unrecognized gain to trigger a
CS.
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Example 2: A constructive sale similarly causes a cost basis adjustment that in turn
converts an unrealized gain on the surviving leg of a straddle to an unrecognized loss,
hence preventing any disallowed loss due to the straddle.
An infinite number of combinations of these can occur and it
is mandatory that the practitioner simultaneously consider all
TAST rules contemporaneously when generating tax books.
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Questions?
Thank you for attending our presentation,
Wash Sales, Constructive Sales
and Straddles: A Primer
www.g2ft.com
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