Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 63-65

1963-1 C.B. 142

Sec. 1233

Sec. 1242

IRS Headnote

A loss sustained on the closing of a short sale of stock of a small business investment company with subsequently purchased stock of the company, acquired solely for the purpose of closing the short sale, is not deductible as an ordinary loss under section 1242 of the Internal Revenue Code of 1954. The nature of the loss is determined under section 1233 of the Code, dealing with gains or losses from short sales.

Full Text

Rev. Rul. 63-65

Advice has been requested whether a loss sustained by an individual on a short sale of stock of a small business investment company, under the circumstances described below, is deductible as an ordinary loss under section 1242 of the Internal Revenue Code of 1954.

On May 28, 1961, the taxpayer had his broker sell short for his account 10 shares of stock in a small business investment company operating under the provisions of the Small Business Investment Act of 1958, 72 Stat. 689. On June 2, 1961, the broker purchased 10 shares of the stock of the small business investment company and, on the same day, used the shares to close the prior short sale. The taxpayer sustained a loss on the closing of this short sale.

Section 1233 of the Code provides, in part, that gain or loss from a short sale of property shall be considered as gain or loss from the sale or exchange of a capital asset to the extent that the property used to close the short sale constitutes a capital asset in the hands of the taxpayer.

However, section 1242 of the Code provides, in pertinent part, that if a loss is on stock in a small business investment company operating under the Small Business Investment Act of 1958, and such loss would, but for this section, be a loss from the sale or exchange of a capital asset, then such loss shall be treated as a loss from the sale or exchange of property which is not a capital asset.

The primary purpose of the Small Business Investment Act of 1958 is to make private equity capital and long-term credit more readily available to small business concerns. In its report accompanying the Small Business Investment Act of 1958, the House Committee on Banking and Currency stated that proposed section 1242, added to the Code by the Technical Amendments Act of 1958, 72 Stat. 1606, C.B. 1958-3, 254, `provides that taxpayers investing in the stock of small business investment companies would be allowed an ordinary-loss deduction rather than a capital-loss deduction on losses arising from the worthlessness or sale of such stock.' (Emphasis added.) H.R. Report No. 2060, Eighty-fifth Congress, 10. See also S. Report No. 1983, Eighty-fifth Congress, C.B. 1958-3, 922, at 925 and 1001.

In view of the foregoing, it is apparent that by section 1242 of the Code Congress intended to encourage the purchase of stock in small business investment companies. Accordingly, the ordinary loss deduction allowable under section 1242 is restricted to losses arising from an investment in small business investment company stock which either becomes worthless or is sold at a loss.

The taxpayer's investment in small business investment company stock was for a period of less than one day and for the purpose of closing his short position. His loss was not attributable to such investment but rather to appreciation in value of the stock during the period the taxpayer maintained his short position, that is, while he had no investment in the stock. Accordingly, the benefits of section 1242 of the Code are inapplicable.

Based on the foregoing, it is held that the loss sustained by the taxpayer on the closing of the short sale of small business investment company stock in the instant case is not deductible as an ordinary loss under section 1242 of the Code. The nature of the loss sustained on this short sale is to be determined, for Federal income tax purposes, under the provisions of section 1233 of the Code and the Income Tax Regulations thereunder.