What Is a Bed and Breakfast Deal?
In investing, a bed and breakfast deal is a practice in the United Kingdom whereby the holder of a security sells it at the end of the day on the last day of the financial year and buys it back the next morning. The purpose of a bed and breakfast deal is for the trader to take advantage of tax savings achieved by selling the security at the end of the financial year.
Typically, the trader makes immediate arrangements with a broker to repurchase the same security at the beginning of the new financial year.
- A bed and breakfast deal is an investing strategy in the United Kingdom where an investor sells a security at the end of the day on the last day of the financial year and buys it back the next morning.
- A bed and breakfast strategy allows investors to minimize the amount of capital gains taxes they must pay.
- The 30-Day Rule of 1998 banned the practice of "bed and breakfasting," forcing investors to wait 30 days before being allowed to repurchase the security they had just sold.
- Using a contract for differences (CFD) is a strategy that allows investors the opportunity to mimic a bed and breakfast deal without violating the 30-Day Rule.
How a Bed and Breakfast Deal Works
Traders carry out bed and breakfast deals in order to maintain an investment portfolio while minimizing UK capital gains taxes. Traders will close out positions at the end of the year and immediately reopen them on the first day of the new financial year to take advantage of the annual tax exemption. Because this practice intentionally seeks to limit capital gains taxes, tax authorities worked hard to minimize the occurrence of bed and breakfast deals. They finally effectively banned the practice with the 30-Day Rule in 1998.
Because of this rule, traditional "bed and breakfasting" is no longer possible in its simplest form. A trader must now wait 30 days before buying shares back, which is fine for capital gains tax planning purposes. However, this does not always appeal to those who wish to stay in the market.
Mimicking Bed and Breakfast Deals with CFDs
There is a way for traders in the UK to effectively replicate a bed and breakfast deal with a little foresight by using a contract for differences (CFD). A contract for differences enables traders to trade the price movement of assets including stock indices, exchange traded funds (ETFs), and commodity futures without actually having to own the asset.
Using a CFD strategy, an investor could sell their security and wait the mandatory 30 days before repurchasing the security. At the beginning of the 30 days, however, the investor can purchase a CFD for the security from a CFD broker. After 30 days, the investor can close out their CFD position and repurchase the security. This strategy enables the investor to stay in the market and participate in the stock's price movent without violating the 30-Day Rule.
CFDs are an advanced strategy that can lead investors to large losses in volatile markets and the industry itself is not highly regulated; because of this, CFD trading is not allowed in the United States.
Example of a Bed and Breakfast Deal
Let's assume an investor in the UK bought 10,000 shares of XYZ Group six months ago at £3.50 and the share price of XYZ Group is currently £3.00. The investor contacts their regular stockbroker and sells the shares at £3.00, thereby actualizing a loss of £5,000 (ignoring broker commissions in this example).
The investor would then call a CFD broker and buy 10,000 shares in XYZ Group. Remember that if you buy a CFD to reflect a long position of XYZ Group shares, the broker will normally go and buy those shares in the market. That ties up the broker's capital and he will want to be compensated for that. So regardless of the initial margin you have paid to buy a CFD, you will pay a daily interest rate on the whole of the consideration.
In this case, let's assume an interest rate of 5%, per annum. This corresponds to £4.11 a day, which adds up to about £123 for 30 days. After 30 days, the CFD position is sold at the prevailing XYZ Group share price. Immediately after the CFDs have been sold, the investor calls up their usual stockbroker and re-buys the 10,000 XYZ Group shares. The bed and breakfast deal is now completed—albeit, with a bit more time and risk involved.
In this scenario, CFDs have allowed the investor to stay in the market regardless of the market direction. If the share price rises within the 30-day period, then profits will be built on the CFD trade to offset re-buying the shares at a higher price. But if the shares slump, then the loss on the CFD trade is compensated by the cheaper price of the shares when they're bought through the stockbroker.