What Is Accommodation Trading?
Accommodation trading is a type of trading in which one trader accommodates another by entering into a non-competitive purchase or sale order. The instance of accommodation trades often happens when two traders are participating in illegal trading. Certain types of accommodation trades can also be known as wash sales.
- Accommodation trading refers to closing a securities transaction at an amount other than the published price.
- The phrase is most often used to refer to illegally conducted trades priced below the currently publishing price of the security. This practice is usually done for evading taxes or laundering money.
- A Cabinet Trade is a type of accommodation that is legal for accounting purposes.
How Accommodation Trading works
An accommodation trade could occur when two traders agree to exchange stock for a price well below the market value of the asset. This exchange allows the seller to realize a considerable investment capital loss on the shares for tax purposes. Later they can reverse the trade.
Accommodation trading is illegal in most countries. Accommodation trading appears in the same situations where money laundering is detected. It is also a tip-off to the financing of terrorist or other criminal organizations.
There are varieties of permitted accommodation trading under securities law. For example, a cabinet trade is a type of accommodation trade in which the option holders can erase an open position from their ledger for the price of 1 cent per share, or $1 per contract.
Example of Illegal Accommodation Trading
For example, suppose Bob, an investor, purchased stock in Company Z at $40 per share. With the tax season approaching, Bob decides to sell the stock to Jill for $25, even though the shares are currently trading in the open market at $50. Bob uses this technique to realize a capital loss of $15 per share on his taxes, and he uses it to lower the taxes paid on capital gains on his other investments. After Bob files his taxes, Jill sells the stock back to Bob for $25 per share. In essence, the trade allows Bob to cheat the tax system because he never actually lost any real value on the stock; he manufactured the trade with the intent of paying less tax.
This kind of trade arrangement, besides being illegal, carries certain price risks with it. For Bob, the risk may be that when he goes to by the stock back from Jill that it has fallen in price below $25, but he is obligated to pay the higher price to Jill, and he won't be able to claim the actual capital loss he experienced. For Jill the risk is that if the stock drops below $25 per share, Bob may not be willing to go through with the original agreement. There are other scenarios that could also play out as a result of price fluctuation that make such trading doubly risky.
What is a Cabinet Trade?
A cabinet trade is a type of allowable accommodation trade that investors can make on shares or unexpired options that still have a significant period of time before expiration. Shares that have dropped so far in price, or a long option contract that has moved so far out of the money that the investor does not expect it to regain any value before expiration, can be closed out at a loss for the purposes of bookkeeping. The investor holding the option is allowed to clear the position from their book for either 1 cent per share or $1 per contract, and thus claim the capital loss for tax purposes.