Tax-aware long/short: what is a borrow fee and is it deductible?
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This article is educational material. It analyzes whether and how borrow fees on short positions may be deductible. This is an analytical exercise, and not personalized guidance. Readers should consult a licensed tax professional knowledgeable about current developments in tax law, who is comfortable rendering an opinion on this matter and preparing their tax return accordingly.
If your clients hold long/short equity strategies in separately managed accounts, they pay borrow fees, the daily cost of borrowing shares sold short.
Borrow fees are obscure, but Interactive Brokers does a magnificent, industry-leading, I’m-very-impressed job of explaining them.
To make borrow fees less obscure, I went way overboard and built a dashboard, pulling the current rates from Interactive Brokers (thousands of names) daily at a new little app I’m calling Borrow Quest.
Are borrow fees, which could be 25-50 (or more) basis points per large cap position, deductible, or were they eliminated with other miscellaneous deductions, like investment advisory fees, when the Tax Cuts and Jobs Act passed in 2017, or is it something else entirely?
Conservatively, there’s something like $100 billion in net tax-aware long/short assets in separately managed accounts today. If we assume 150/50 is the average gross exposure, then that means $50 billion is in short positions. If it costs 30 basis points in borrow fees annually to hold these short positions, then we’re talking about $150 million in costs that are, or are not, deductible in some shape or form. Further assuming a marginal tax rate of 30%, that's $45 million, or very roughly 4-5 basis points per net dollar invested in the long/short strategy overall ($400-$500 per $1 million). Obviously, approximately.
Yawn?
In my mind, this is worth chasing down, or perhaps going through the exercise of chasing it down, but as you’ll soon see, it’s not so straightforward.
Are borrow fees deductible?
