Question

In: Accounting

1A. Briefly describe the three parties involved in a short sale? 1B. An investor own 500...

1A. Briefly describe the three parties involved in a short sale?

1B. An investor own 500 shares of stock that has been held for a 5 years that has a basis of $20,000. The investor also owns 500 shares which have been held for 3 months with a basis of $40,000. At that time the investor sells short 500 shares of stock for $27,500. If the investor closed the short sale by delivering the shares held for 5 years what is the amount of the gain/loss Is it long term or short term? Why? What would happen if the investor delivered the shares held for3 months?

1C. An investor buys 1,000 shares of a mutual fund on December 3, 2013 for a total cost of $50,000. On December 23, 2013 the investor received a long-term capital gain dividend on those shares of $3,000. On February 14, 2014 the investor sells the shares for $48,000. What is the amount of the investor’s gain or loss on the sale? What is the character of the gain/loss?

1D. An investor buys 1,000 shares of Corp ABC on Jan. 31 2018. ABC will announce its quarterly earnings on May 15, 2018. The investor is nervous because it is afraid ABC will miss the earnings forecast and will decline in price. The investor buys 10 puts on ABC on May 14. The earnings actually exceeded investors’ expectations and ABC goes way up in value. The investor sells the puts on May 16. On February 15, 2019, the investor sells the ABC stock for a substantial gain. What is the nature of the gain for federal income tax purposes?

Solutions

Expert Solution

1A. Short Sale

- Short sale is the one in which the seller wants to sell his property which is under mortgage mainly because the worth of his property is "Short" than the mortgage obligations. In short sales, property held long term is substantially identical to property sold short (at that time) results in aly loss on the short sale is being treated as long term. Generally parties involved in a short sales are buyer, seller and the lendor.

Buyer is the person who is willing to purchase the property.

Seller is the person whose property is on the sale and who want to get rid of his mortgage obligations. Since, he is selling the house for which lender has lent the money, he has to take permission of the lendor.

Lender is the one who must approve the short sales. This is mainly because the lender is agreeing to accept funds that are less than the full balance.

1B. As per IRS, to correctly arrive at your net capital gain or loss, capital gains and losses are classified as long-term or short-term. Generally, if you hold the asset for more than one year before you dispose of it, your capital gain or loss is long-term. If you hold it one year or less, your capital gain or loss is short-term.

So, if he sold shares that he owned 5 years back, they are long term and the gain/loss that he have is "Long term capital gain".

Capital Gain/(Loss) = Selling price - Adjusted basis

= 27,500 - 27,000

= $ 7.500 (Long term capital gain).

So, if he sold shares that he owned 3 months back, they are short term and the gain/loss that he have is "Short term capital gain".

Capital Gain/(Loss) = Selling price - Adjusted basis

= 27,500 - 40,000

= $ (12,500) (Short term capital loss).

1C. As per IRS, to correctly arrive at your net capital gain or loss, capital gains and losses are classified as long-term or short-term. Generally, if you hold the asset for more than one year before you dispose of it, your capital gain or loss is long-term. If you hold it one year or less, your capital gain or loss is short-term.

Here, since the investor sells the mutual funds at less than a year, the funds are short term and the gain is Short term capital gain.

Capital Gain/(Loss) = Selling price - Adjusted basis

= 48,000 - 50,000

= $ (2,000) (Short term capital loss).

Capital gains distributions such as dividends are reported on Form 1099-DIV. Capital gains distributions are taxed at long-term capital gains tax rates no matter how long you personally own the shares in the mutual fund.

1D. As per IRS, holding option for less than one year, your sale will result in a short-term gain or loss, else long tearm gain/loss.

So, his loss under the put option will be Short team capital Loss.

For the shares he purchased on Jan. 31, 2018, he is holding asset for more than 1 year when he is disposing it on Feb 15, 2019. So the same is long term and the gain for the same is Long term capital gain.

As per IRS, Short term capital loss can be offset against the long term capital Gain.

So Net capital gain = Long term capital gain - Short term capital loss.


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