Wall St., Washington Set Stage For Shorting

Thanks to an unusual combination of Wall Street economics and Washington politics, a special opportunity exists right now to practice an old investment tactic known as “selling short against the box.”

This maneuver, which has its costs as well as benefits, can be used by anyone who wants to nail down a capital gain on a stock or similar investment without having to pay tax on the profit right away.

Every year at about this time, many advisers recommend shorting against the box as a way to postpone incurring a tax liability until after New Year’s.

The bull market that has carried the stock market to record highs this year has produced a bumper crop of capital gains to protect.

In addition, because of pending tax legislation, shorting against the box now can achieve another purpose - delaying realization of the profit until after Congress decides whether, how and when to lower tax rates on capital gains from investments held for more than one year.

“By using this perennial yearend tax planning strategy this year,” says Marc Britton, director of personal financial planning at the accounting firm of KPMG Peat Marwick, “you may obtain a double benefit - deferring the gain until 1996 and being taxed at a lower rate.”

By way of illustration, suppose you own 100 shares of Hypothetical Corp. bought in mid-1994 for $10 apiece, or $1,050 including commissions. You could sell it today for $1,600, or $1,550 after paying the broker, and thus net a $500 profit.

That $500, however, would go into your accounts for 1995 as a capital gain subject to federal income tax (up to 28 percent at current rates) plus any state and local income tax that may apply where you live.

To postpone this day of reckoning, you can go short against the box - keeping the 100 shares you own, but borrowing another 100 from your broker and selling it short, in the manner of stock traders who sell short hoping to buy back in later at lower prices.

Since you now have offsetting long and short positions in the stock, you have eliminated your exposure to the market. Whether the price of the stock rises or falls from here on out, you can neither gain nor lose. At the same time, you have delayed realizing your paper profit.

You can keep it frozen not only past yearend, but also until proposals now before Congress to cut the capital gains tax rate are acted on.

“As the administration and Congress haggle, the effective date could well become Jan. 1, 1996, or never,” Britton says.

Britton sees still another potential advantage to shorting against the box.

The market-neutral position you take cushions you against the possibility that your and other stock investments may suffer a temporary setback if a change in tax rates unleashes an outburst of selling by investors who have been waiting for just such an opportunity.

The disadvantages? Shorting against the box incurs extra commission costs, plus interest charges on the borrowed stock. If you are short at the time a dividend is paid, you do not receive it.