A short sale is treated differently for tax purposes, in that a gain or loss may be recognized. In a short sale, you enter into a contract to sell property that you borrow in order to deliver it to your buyer. Later, you close the short sale and satisfy your obligation to your lender by buying substantially identical property and delivering it, or by delivering property you already held, but did not want to transfer at the time of the short sale.
On a short sale you do not realize any gain or loss until you deliver the property to close the sale. If the property you deliver to close the sale is a capital asset (a stock held for investment purposes, for example), you will have a capital gain or loss on the short sale. But you may have a constructive sale if you sell short an appreciated financial position and do not close the short sale.
Constructive Sales
A short sale may be deemed a constructive sale of an appreciated financial position. In this case you must recognize the gain for tax purposes, as if the position had been disposed of at its fair market value on the date of the constructive sale. Then, a new holding period starts on the date you recognize the gain on the constructive sale, and when you close the transaction, you would decrease the gain (or increase the loss) you realize by the amount of the gain you recognized on the constructive sale.
A short sale will be deemed a constructive sale if it involves the same property or property that is substantially identical to the property that has an appreciated financial position. An appreciated financial position is an interest in a stock, a partnership interest, or a debt instrument (bond, for example), that would result in a gain if you disposed of it.
You will not have to report a constructive sale of an appreciated financial position if you closed the transaction within 30 days after the end of your tax year, you held the appreciated position during a 60-day period beginning on the date you closed the transaction, or your risk of loss was reduced at any time during this 60-day period.
For example, if you purchase 100 shares of stock in company A at $20 a share on June 1st and later sell short similar stock in company A on October 1st at $25 per share, and you do not close the short sale by January 30 of the following year, you would have a constructive sale, because if you had sold the stock you purchased on the date of the short sale, you would have had a gain of $5 per share. You would report a short-term capital gain of $500 on your tax return.