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Learn about our Taxable Events Webinars.


Glossary

Our Glossary contains brief definitions of both taxable events and concepts integral to calculating cost basis adjustments and taxable gains and losses.


Branching (wash sales)

Branching occurs when a lot is broken into separate components (sub lots) based on the replacement lot size. Per the wash sale rule, when the replacement lot is larger than the original lot, only a portion of the replacement lot has its basis adjusted. Conversely, if the replacement lot is smaller than the original, then only a portion of the original loss is disallowed.

In the case where the replacement is larger, one sub lot (A) is created whose size is identical to the original lot. The other sub lot (B) contains the balance of the replacement lot’s position. Sub lot (A) has its cost basis and acquisition date adjusted according to the wash sale rules and sub lot (B) retains the original cost basis and acquisition date of the replacement lot.

In the case where the original is larger, it is also broken into two sub lots. The first sub lot (A) is created with a size equal to the replacement, and its loss is disallowed. The other sub lot (B) contains the balance of the original lot’s position and its loss may be recognized.

Note that in both cases, multiple sub lots can be created since multiple wash sales impact the same lot. In other words, the branches can branch.

Video clip on Branching
To access a short video about Branching, please click here.

Webinars on Wash Sales (Branching)
Wash Sales, Constructive Sales & Straddles: A Primer
Wash Sales: A Closer Look

Relevant white papers
Basic Wash Sales
Holding Period Adjustments for Wash Sales

For a more comprehensive discussion on wash sales, click here.

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Chaining (wash sales)
There are "chained" or "rolling" wash sales. Chaining is the result of a consecutive series of Buy-Sell-Buy scenarios (Buy-Sell-Buy-Sell-Buy). There is no limit to the number of potential trades in a single chain. Chaining becomes especially complex when the cost adjustment to the original replacement Buy creates a subsequent wash sale. This occurs because the cost basis of the replacement Buy is increased by a sufficient amount to cause a subsequent sale to be a loss instead of a gain. This scenario creates additional replacement Buys, whose holding periods must be adjusted separately.

The chaining effect dictates that the cost basis adjustment affecting a replacement position must be taken into account when determining the amount of recognizable loss that occurs due to this position being retired. This can adjust forward the gain or loss from the retirement as well as change its character. Three potential effects can result. (1) If the position is disposed of for a gain, that gain can be reduced. (2) However, if the adjustment is deep enough, the gain can become a loss, which therefore makes the disposition a candidate for a new wash sale. (3) If the disposition was made at a loss, the amount of loss is increased. The interesting effect is that the original loss can be carried forward through a sequence of dispositions that can be viewed as a “chain.” Chains can occur over multiple years with no limit on the number of links.

Video clip on Chaining
To access a short video about Chaining, please click here.

Webinars on Wash Sales (Chaining)
Wash Sales, Constructive Sales & Straddles: A Primer
Wash Sales: A Closer Look

Relevant white papers
Basic Wash Sales
Holding Period Adjustments for Wash Sales

For a more comprehensive discussion on wash sales, click here.

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Constructive Sales
A transaction where a security is sold short at the same time the taxpayer owns appreciated long positions in the same or substantially identical security. The rule also works when a taxpayer purchases long positions at the same time they hold open short positions. These rules force the taxpayer to take realized gains as if they sold (or covered) one of the previously open, appreciated positions. The rule also affects the holding periods involved with the transactions.

Exceptions to the Constructive Sale rule
There are exceptions to this rule when the second position can qualify as a “temporary” hedge. When the exception rules fail, there is a “true” box and hence a constructive sale.


Section 1259 allows for two exceptions -- Closed Transaction Exception and Serial Hedge Exception -- in which investors do not have to pay capital gains.

The Closed Transaction Exception 1259(c)(3)(A), applies when all of the following conditions exist for a pair of trades:

    1. The transaction that would have created the constructive sale is closed before the
        end of the 30th day after the end of the tax year.
    2. The appreciated financial position was held throughout the 60-day period beginning
        on the date on which the transaction closed.
    3. The risk of loss was not reduced at any time during that 60-day period by holding
        certain other positions.

The Serial Hedge Exception 1259(c)(3)(B), applies when all of the following conditions exist for a pair of trades:

    1. This risk reduction position is closed before the 30th day following the end of the tax
         year.
    2. Leg-1 continues to remain open for 60 days after the risk reduction position is
         closed
    3. No new risk reduction transaction occurs during the 60 days unless it also meets
         these criteria

Video clips on Constructive Sales
Constructive Sales
Crossing Transactions
Example: Serial Hedge Exception
Example: Closed Transaction Exception Succeeds
Example: Closed Transaction Exception Fails

Webinars on Constructive Sales
Wash Sales, Constructive Sales & Straddles: A Primer
Constructive Sales: The Exceptions

Relevant white papers
Constructive Sales
Advanced Topics in Constructive Sales: The Exceptions

For a more comprehensive discussion on constructive sales, click here.

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CrossingTransactions (constructive sales)
The Tax Code gives a list of transaction types that can cause a constructive sale. We call these "Crossing Transactions." We believe our term conveys more meaning. A Crossing Transaction is a transaction that appears to invoke the constructive sale rule. The transaction must be on the same or substantially identical property or a stand-in transaction for the same or substantially identical property. Only once you determine whether the exceptions are satisfied will you know if the Crossing Transaction has instigated a “true” box and a constructive sale must be recognized.

The exact text of 1259(c)(1) -- the exact conditions for a “Crossing” Transaction:

  • enters into a short sale of the same or substantially identical property,

  • enters into an offsetting notional principal contract with respect to the same or substantially identical property,

  • enters into a futures or forward contract to deliver the same or substantially identical property,

  • in the case of an appreciated financial position that is a short sale or a contract described in subparagraph (B) or (C) with respect to any property, acquires the same or substantially identical property, or

  • to the extent prescribed by the Secretary in regulations, enters into 1 or more other transactions (or acquires 1 or more positions) that have substantially the same effect as a transaction described in any of the preceding subparagraphs.


Video clips on Constructive Sales
Constructive Sales
Crossing Transactions

Webinars on Constructive Sales
Wash Sales, Constructive Sales & Straddles: A Primer
Constructive Sales: The Exceptions

Relevant white papers
Constructive Sales
Advanced Topics in Constructive Sales: The Exceptions

For a more comprehensive discussion on constructive sales, click here.

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Dividends Received Deductions
When a corporation receives dividends from a company in which it has an ownership stake, and those dividends qualify for a tax deduction. Under I.R.C. § 243, a corporation can qualify for the Dividends Received Deduction on a dividend when it meets certain criteria and thus becomes eligible for a preferable tax treatment.

Webinars on Dividends Received Deductions
Tax Analysis of Dividends

Video clip on Dividends Received Deductions
Dividends Received Deductions

For a more comprehensive discussion on dividends received deductions, click here.

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Offsetting Positions
A position that substantially reduces any risk of loss you may have from holding another position. Since the term “risk” is used, it becomes clear that you need to understand the basics of risk management to have some hope of interpreting what this means. It is somewhat analogous to the concept of substantially identical but is far more useful in that it actually constitutes a definition in the sense that you might find one in a dictionary. This concept is not called out by the qualified dividend rule, but the text is similar enough that we recommend you use this definition in order to determine when a dividend is disqualified.

History This concept was introduced in 1981 as part of the Economic Recovery Tax Act of 1981 (ERTA).

Relevant white papers
Using Market Risk Concepts to Refactor Tax Shelters

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Qualified Dividends
A normal cash dividend received from a position on a stock where the stock has been held for 61 days or more of a qualification period, which is a 121-day period centered on the dividend pay date. This allows long-term holders of stocks to pay a tax rate similar to that of capital gains for dividends received from those stocks. The idea was to encourage companies to pay dividends and for investors to demand them. The complex part involves a clause within the rule to disqualify a dividend when “risk of loss” is diminished. Typically, this is deemed to occur using similar rules to those used for determining whether a straddle has been created.

Webinars on Qualified Dividends
Tax Analysis of Dividends

Video clip on Qualified Dividends
Qualified Dividends

Relevant white papers
Qualified Dividend Income

For a more comprehensive discussion on qualified dividends, click here.

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Short Dividends / Section 263(h)
When a taxpayer holds a short position that receives a dividend, they generally make a payment in lieu of that dividend to the lender of the underlying stock. Section 263(h) prevents the taxpayer in question from deducting that payment as an investment expense if the short position was not closed within 45 days. In the event that this deduction is barred, the amount of the disallowed deduction is instead applied to the basis of the long position used to close the short sale. This means the same adjustment is eventually made, but there are three notable differences.


Webinars on Short Dividends
Tax Analysis of Dividends

Video clip on Short Dividends
Short Dividends

For a more comprehensive discussion on short dividends / Section 263(h), click here.

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Tax Straddles
A pair of transactions that is created by taking two offsetting positions that share the same underlying security. One of the two positions holds long risk and the other is short. If one of the positions is sold for a loss and the other is held until the end of the tax year, then the loss on the closed position is disallowed to the extent there are unrealized gains on the surviving position. There are rules that allow other transactions to become attached to the straddle by becoming “Successor Positions” or “Offsets to Successor Positions.” If any of the original positions, successor positions or offsets are still active at the end of the tax year, all realized losses on any of the other positions, successors or offsets are potentially disallowed. Straddles can also impact the holding periods of transactions that are tied to it.

Video clips on Tax Straddles
To access a short video about Tax Straddles, please click here.
Video clip on Tax Straddles: History & Concepts (Section 1092)
Video clip on Basic Tax Straddles (Section 1092)
Video clip on Identified Tax Straddles (Section 1092)
Video clip on Qualified Covered Calls (Section 1092)
Video clip on Mixed Tax Straddles (Section 1092)

Webinars on Tax Straddles
Tax Implications of Straddles
Wash Sales, Constructive Sales & Straddles: A Primer

Relevant white papers
Tax Implications of Straddles


For a more comprehensive discussion on straddles, click here.

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Substantially Identical
Generally, securities are not considered 'substantially identical' if they are substantially different in any material feature, or because of differences in several material features considered together (i.e., even though each of such differences considered alone might not be regarded as substantial). Normally securities of two companies are not substantially identical, and preferred stock are not substantially identical to common stock. However, Publication 550 does call out some specific exceptions for mergers and convertible securities. There is no single source that provides a definition of substantially identical; the guidelines are spread across multiple different sources.

History This concept was introduced by the Revenue Act of 1921.

Video clip on Substantially Identical
To access a short video about Substantially Identical, please click here.

Webinars on Substantially Identical
Wash Sales, Constructive Sales & Straddles: A Primer
Wash Sales: A Closer Look

Relevant white papers
Using Market Risk Concepts to Refactor Tax Shelters
Advanced Topics in Wash Sales: Substantially Identical Bonds

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Wash Sales
A wash sale is the disposition of a loss position coupled with a replacement position. There are three types of replacements: basic, substantially identical or those delineated as a valid replacement.

The replacement must occur within a 61-day window that includes the disposition date as well as 30 days on either side of that date. The amount of loss disallowed by the wash sale cannot be recognized in the calendar year in which it occurs, but it can be recognized in the year in which the replacement position is disposed of. This re-allowance is attained by a cost basis adjustment to the replacement position. A wash sale also affects the holding period of the replacement position.

Video clip on Wash Sales
To access a short video about Wash Sales, please click here.

Webinars on Wash Sales
Wash Sales, Constructive Sales & Straddles: A Primer
Wash Sales: A Closer Look

Relevant white papers
Basic Wash Sales
Holding Period Adjustments for Wash Sales
Advanced Topics in Wash Sales: Substantially Identical Bonds
Using Market Risk Concepts to Refactor Tax Shelters

For a more comprehensive discussion on wash sales, click here.

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