Tax Straddles
Updated: Aug 27
Tax straddles are some of the most complex tax rules in the Internal Revenue Code and can appear in unanticipated situations.
Tax straddles are designed to restrict a trader from deducting losses before recognizing gains associated with a particular trade or trades.
A tax straddle is an offsetting position in securities if there is a substantial diminution of the risk of loss with regard to holding one or more other position.
For example, the classic straddle example is being "short against the box" or holding a long position as well as a short position in the same stock. If the stock price increases for the long position, the short position will lose the exact same amount, and vice versa.
Straddles are covered in the Internal Revenue Code Section 1092 and Regulations Section 1.1092.
If one reads through the Regs Sec 1.1092 examples, almost everything is a straddle, which strikes fear in most traders. The basic premise of the IRS is to disallow the loss on one position before the recognition of gain on the other position. To prevent this, the consequences are somewhat draconian in the deferral of losses, basis adjustments and change in holding periods.
However, it is not as bad as one would think. I don't know many who are "experts" in tax straddles, including me, but neither is the IRS. This is not a statement that you should do whatever you want and completely disregard the rules, but I have never seen the audit of a trader strictly because he/she missed a tax straddle and did not defer the loss.
Plus, there is a cost/benefit issue when preparing a tax return - sometimes the cost of compliance simply outweighs the benefits. I have examined tax straddles for clients on several occasions while preparing their returns - at no cost or a substantial discount - just to see what the difference in the tax liability would be. In most cases it is in the hundreds of dollars, not thousands or ten thousands. With that said, personally I would make a best efforts attempt at properly reporting straddles and if an audit ensues, pay the tax plus interest and penalties, which might amount to about $25-$50 but if the client paid for my time, the fees would be $400-$500 ... which is a no-brainer.
Wash sales are a form of straddle and are reported by brokerages on Form 1099-B. Sometimes, especially with option trades, I disagree with the broker's position because they must take the most conservative position in reporting trades so as not to run into IRS scrutiny and as you have perhaps read on this website, it is my personal opinion that options on the same underlying but varying expirations, strikes or both are not substantially identical.
That said, I receive a number of requests to consult on the possibility of a tax straddle in a trader's positions. This is somewhat difficult because I do not consult on trades and typically only comment on tax concepts and rules.
Further, I am an advocate for the taxpayer and IRS is somewhat of an adversary, who strikes fear in traders with terms like "straddles", "deferrals" and the like, in addition to the radio spots comparing an IRS audit to the Spanish Inquisition ... it is not.
Take a look at the straddles page on this website before contacting me. It is difficult to tell whether a straddle - except in the most obvious trades, like the one mentioned above, having a long and short position on the same underlying with the same expiration and similar strikes - can be considered a straddle by IRS. However, once the position(s) has expired, the straddle is gone forever.
Another consideration is, if you meet the trading requirements as a Trader in Securities, make the mark to market election to eliminate most of this issue.
Don't fret about it or overthink it!!
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