8626 / Are there any special rules applicable in determining whether a gain or loss is long-term or short-term when a short sale is involved?

Whether capital gain or loss on a short sale is long-term or short-term will ordinarily be determined by the seller’s holding period in the stock used to close the sale.¹ For most purposes, the capital gain or loss is long-term if the holding period is more than one year. If the holding period is one year or less, the gain is short-term. (See Q 8625 for a detailed discussion of the holding period requirement.)

In a “short sale,” a seller agrees to sell stock to another at a fixed price on a future date. If the future date is more than a year from the date the taxpayer acquired the stock, he or she would be able to convert short-term capital gain (taxed at ordinary tax rates, i.e., up to 37 percent) to long-term capital gain (i.e., with rates of 0 percent, 15 percent or 20 percent). IRC Sections 1233 and 1259 are designed to prevent such abuse.

Example: On March 1, 2025, Asher acquires stock for $200. On September 1, the fair market value of the stock is $300. To lock in the appreciation, Asher enters a short sale to close on April 1, 2026. Without IRC Sections 1233 and 1259, Asher would effectively convert a short-term holding period into a long-term holding period; and, thus, recognize long-term capital gain.

(1)  If on the date the short sale is closed (see below), any “substantially identical property” has been held by the seller for a period of one year or less, any gain realized on property used to close the sale will, to the extent of the quantity of such substantially identical property, be short-term capital gain.² This is true even though the stock actually used to close the short sale has been held by the seller for more than one year. This rule does not apply to losses realized on the property used to close the sale;