If, while holding a short sale, a dividend was issued which ultimately came from your brokerage account, the amount may be able to be deducted as an investment expense on Federal Schedule A (Form 1040) Itemized Deductions, Line 9 as Investment Interest.

If the payment you had to make to the lender, in lieu of dividends distributed on stock which you borrowed for a short sale, qualifies as an investment expense, enter this amount in TaxAct^® by following these steps:

1. From within your TaxAct return (Online or Desktop), click Federal (on smaller devices, click in the top left corner of your screen, then click Federal).
2. Click the Itemized or Standard Deductions dropdown, then click Interest expenses.
3. On the screen titled Enter the amount of investment interest you paid or accrued in 2022, click the data entry field below Investment interest expense from other sources, and type the amount.

Per IRS Publication 550 Investment Income and Expenses (Including Capital Gains and Losses), page 56:

Payments in lieu of dividends. If you borrow stock to make a short sale, you may have to remit to the lender payments in lieu of the dividends distributed while you maintain your short position. You can deduct these payments only if you hold the short sale open at least 46 days (more than 1 year in the case of an extraordinary dividend, as defined later) and you itemize your deductions.

You deduct these payments as investment interest on Schedule A (Form 1040 or 1040-SR). See Interest Expenses in chapter 3 for more information.

If you close the short sale by the 45th day after the date of the short sale (1 year or less in the case of an extraordinary dividend), you cannot deduct the payment in lieu of the dividend you make to the lender. Instead, you must increase the basis of the stock used to close the short sale by that amount.

To determine how long a short sale is kept open, do not include any period during which you hold, have an option to buy, or are under a contractual obligation to buy substantially identical stock or securities.

If your payment is made for a liquidating distribution or nontaxable stock distribution, or if you buy more shares equal to a stock distribution issued on the borrowed stock during your short position, you have a capital expense. You must add the payment to the cost of the stock sold short.

Exception. If you close the short sale within 45 days, the deduction for amounts you pay in lieu of dividends will be disallowed only to the extent the payments are more than the amount you receive as ordinary income from the lender of the stock for the use of collateral with the short sale. This exception does not apply to payments in place of extraordinary dividends.

Extraordinary dividends. If the amount of any dividend you receive on a share of preferred stock equals or exceeds 5% (10% in the case of other stock) of the amount realized on the short sale, the dividend you receive is an extraordinary dividend.

Use Form 4952 Investment Interest Expense Deduction to figure your deduction for investment interest.

Per IRS Instructions for Form 4952, page 3:

Exception. You don’t have to file Form 4952 if all of the following apply.

• Your investment income from interest and ordinary dividends minus any qualified dividends is more than your investment interest expense.
• You don’t have any other deductible investment expenses.
• You don’t have any carryover of disallowed investment interest expense from 2023.

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