What is Manufactured Payment
A manufactured payment is made to pass through dividend and interest payments from the borrower to the lender of those securities. Manufactured payments, represented as interest or dividend payments, occur frequently in securities lending. In such an arrangement, title to the securities passes to borrower, but the lender customarily maintains the right to payments which accrue on the security.
BREAKING DOWN Manufactured Payment
Short selling is the most common situation in which one must borrow securities and a manufactured payment might be made. In order to sell a stock short, a trader must borrow the stock. Since the short seller has borrowed the security, dividend payments made on the stock during the term of the loan must be paid to the lender. This can be a significant cost of short selling if a stock pays a high dividend yield. Brokers should notify the borrower of a security of the possibility that they may need to make a manufactured payment. They may even reduce the borrower's cash position in your account to cover the payment.
Tax Rules Around Manufactured Payments
If a trader sells a stock short, they will have to remit payments to the lender in lieu of the dividends if the trader holds the short sale open at least 46 days. If a trader closes the short sale by the 45th day after the date of the short sale, they can't deduct the manufactured payment on their taxes. Instead, they must increase the cost basis of the stock used to close the short sale by that amount.
To determine how long a short sale is kept open, a trader shouldn't include any period during which they hold, have an option to buy, or are under a contractual obligation to buy identical stock or securities. They also shouldn't include any period during which they are considered to have diminished their risk of loss from the short sale by reason of holding one or more other positions in substantially similar or related properties.
Manufactured payments should be treated as investment interest expenses, subject to all of the rules and regulations involving investment interest expense. Report these expenses on Schedule A of a tax return. If a trader doesn't itemize their deductions, investment interest expense won't be tax-effective. If a trader doesn't take the deduction because they don't itemize deductions, the deduction is lost forever. There are no "elections" that you can make in order to use the investment interest deduction to reduce any gain (or increase the loss) when you eventually close your short position.