The recent short selling activity in GameStop has motivated some to become new “investors” because of the idea of making fast money through such trading. However, many are unaware of the dangers of short selling, along with the tax implications that come along with any potential quick profits.
One of the dangers in short selling is that losses can be unlimited. In a short sale, an investor bets that the price of a stock will decline. The investor borrows shares of a particular stock from a broker to return the shares later hoping that the price will decline before they purchase the stock for repayment. Borrowing from the brokerage firm is typically done on margin which also includes a high rate of interest.
These transactions are taxable as ordinary income at the investor’s current rate versus stocks that are held for a year and one day are taxed at long-term rates (currently 15%). These short-term gains also may be subject to the Net Investment Income Tax (NIIT). For some investors, this could result in a federal tax rate exceeding 40%, which does not include state and local taxes.
Some are familiar with tax lost harvesting which is selling holdings at a loss to offset profits. If you are short selling, you will also want to consider tax gain harvesting.
So ultimately, short sellers should want to know that the return they may get is large enough to offset the higher tax rates compared with other types of investing.
Some consider short selling as investing – while others consider it gambling, as the stock price has nothing to do with the current or future success of the company.
-Kevin Theissen, HWC Financial
