7533 / For purposes of the short sale rules, what are “arbitrage operations”?

“Arbitrage operations” are transactions involving the purchase and sale of stock or securities (or the right to acquire stock or securities) entered into for the purpose of profiting from a current difference between the price of the property purchased and the price of the property sold. The property purchased must either be identical to the property sold (e.g., stock X trading for different prices on different exchanges) or must entitle the owner to acquire property that is identical to the property sold (e.g., bonds convertible into stock X). To qualify as an arbitrage operation for purposes of the short sale rules, the taxpayer must properly identify the transaction as an arbitrage operation on the taxpayer’s records as soon as the taxpayer is able to do so; ordinarily, this must be done on the day of the transaction. Only property properly identified as such will be treated as property acquired for arbitrage operations.¹

Property that has been properly identified as acquired for arbitrage operations will continue to be treated as such even though, because of subsequent events, the taxpayer sells the property outright rather than using it to complete the arbitrage operation.² See Q 7534 as to the effects of disposing of such property without closing a short sale that was entered into as part of the arbitrage operation.

It is unclear whether an arbitrage operation may be subject to treatment as a conversion transaction (see Q 7615, Q 7616) or whether it may constitute a constructive sale of an appreciated financial position (see Q 7617 to Q 7621).

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1.   IRC § 1233(f); Treas. Reg. § 1.1233-1(f)(3).

2.   Treas. Reg. § 1.1233-1(f)(3).