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I want to hedge a position I have on employer stock in a 401k

Customer Question

I want to hedge a position I have on employer stock in a 401k plan that I will be taking an NUA distribution on soon. The NUA value is, of course, LTCG. I want to hedge the position so that I can sell the stock over at least two calendar years (2013 and 2014). I also own some of the stock in a conventional account, that I do not want to sell because of its basis. I think I cannot sell short without creating a problem with either my conventional holdings or my NUA holdings, or both. I have considered PUTS, but need to know that I do not create similar problems of constructive selling, converting NUA LTCG to STCG or ordinary income, etc.
Submitted: 1 year ago.
Category: Tax
Expert:  jgordosea replied 1 year ago.

Greetings,

 

Except for the possibility of having a wash sale in a taxable account for shares held in a retirement plan (or vice versa) , there is no other interaction of the accounts.

That is, the gain or loss from the one type of account does not affect the holding period of the same stock held in the other type of account.

 

Neither does selling short in nonretirement accounts change the holding period of stock that you already own prior to the short sale (presuming that you are not using those shares to satisfy the short sale but buying other shares or trading the option.)

 

You will want to keep any stock transferred from the retirement plan in an account that is separate from your other holdings to easily be able to identify the holding period from a given sale of the stock.

 

Please ask if you need more discussion or clarification.

Thank you.

 

 

Customer: replied 1 year ago.

That sounds smooth when you say it fast! Can you provide a reference to the regs.


I have seen enough to know that there are areas of tax risk if not implemented properly, especially if selling short for shares one already owns. Understand also, that after I do the NUA distribution, the NUA shares and the PUTs would be in the same account; this raises the question of whether it matters if the PUTs are acquired before or after the NUA distribution.

Customer: replied 1 year ago.
Relist: Answer quality.
Expert:  jgordosea replied 1 year ago.

Hello again,

 

Not sure what more you need.

 

I will opt out so another expert can help.

 

Thanks.

Expert:  PDtax replied 1 year ago.
Welcome to the site. Different expert here. I'm PDtax.

The use of puts is not prohibited in protecting NUA treatment and value. I am unaware of any limitations on their use, or that of a collar, to protect the economic value of your NUA. Their use does not 'taint' the LTCG treatment of the NUA appreciation.

I believe the gain/loss on liquidating your put positions will be treated separately from the NUA tax treatment, which is ordinary income treatment on the basis, LTCG on the appreciation, and 10% premature distribution penalty on the distribution if under age 59 1/2.

Thanks from Just Answer. If you have any follow up to ask, please ask for the Expert of your choice by name so we know who should respond. I'm PDtax.

Customer: replied 1 year ago.

Here is what I think I know:


If you exercise a put option and sell the underlying securities, the premium you paid for the option (plus commissions and fees) reduces the amount you realize on the sale of the underlying securities. Determining whether you have a short-term or a long-term gain or loss depends on when you purchase the underlying securities in relation to when you bought the put. If you sell securities that you had held long term at the time you bought the put, you will have a long-term gain or loss.



If you sell securities you had held short term at the time you bought the put, or if you purchased the securities after you bought the put (but before you exercised the put), the transaction will be treated as a short sale. That is, your holding period for the securities starts on the date you exercise the option, regardless of when you actually bought them.



If the put is a married put, the gain or loss will be short-term or long-term, depending on how long you had held the securities before you exercised the put.


 


I 'm looking for something to clarify how NUA assets are handled with regard to date of acquisition. While I've been holding the assets in a 401k plan for a very long time, I am distributing them out as NUA in the near future so one might say they I've "held" them short term, or that I acquired them after the PUT was purchased.

Expert:  PDtax replied 1 year ago.
There are two holding period issues. The NUA value is fixed and determined when the shares are distributed, as is the holding period (assumed long term). Then there is another holding period. The time between your distribution and sale. That can be short term or long term, and the price change will be gain or loss, subject to its own tax treatment and put/call option strategies.

Here's an example from http://www.goodfinancialcents.com/net-unrealized-appreciation/;

Bob had 500 shares of company stock in his 401k with a basis of $10/share. He took a lump-sum distribution at retirement in January 2006. The stock’s FMV was $20/share. Bob sold the stock in February 2007 at a FMV of $25/share. Bob recognizes ordinary income in the year of the distribution on the $10/share basis, which is $5,000. In the year of the stock sale, he then recognizes $5,000 of long-term capital gains ($20/share at distribution less the $10/share basis) and also $2,500 of long-term capital gains on the gain since the distribution ($25 FMV – $20/share at distribution). Had Bob not held the stock for one year after the distribution, the $5/share gain since distribution would have been short-term capital gains.

The NUA gain character and amount in this example does not change. The put/call interplay you mention will only relate to the post-distribution gain/loss.

Thanks again for asking at Just Answer. I'm PDtax.
Customer: replied 1 year ago.

I do understand everything you said about NUA.


I'm concerned about:


If you sell securities you had held short term at the time you bought the put, or if you purchased the securities after you bought the put (but before you exercised the put), the transaction will be treated as a short sale.


 


I'm trying to determine if hedging NUA is covered in the regs anywhere to eliminate the possibility that "holding period" associated with hedging does not inadvertently pull NUA into short sale. I understand the NUA part; but I'm not so sure one can extrapolate basic NUA principles to the implication of hedging NUA.

Expert:  PDtax replied 1 year ago.
There are a lot of ways to hedge your gains. The best part of the potential is that none, and I mean none, of the hedging I looked at converted NUA gains.

The best way to look at it is the shares are not yours until the day of transfer. the NUA gain is not share based, but instead tax law based. Your holding period for the shares starts the day you own them, which is the day of distribution out of your 401(k) plan.

Nothing can convert your holding period of the shares to any period before the day you own them. Additionally, any transactions you enter into after taking possession will not cause a look back or conversion of the NUA gain into anything else.

I do not believe the put option strategy will impact your NUA gain tax treatment. Since your goal is to recognize some LTCG in two accounting periods, put options are only one way to hedge the gains and time the gain recognition. But the puts will not impact tax holding periods prior to actually holding the shares.
Customer: replied 1 year ago.


Your concept of NUA being tax-law based rather than holding period base may be the string I need to pull to tie thse concepts together. I'm going to accept this as an answer.


Thanks

Expert:  PDtax replied 1 year ago.
thanks.

PDtax

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