Any tax consequences: cap gains dist. on shorted ETF

If you sell shares short you have to pay the dividends to whoever the shares are borrowed from.

If it went ex-div on the 20th, then anybody who held a position overnight on the 19th is involved.
If you were short overnight, you owe the distribution.
If you were long overnight, you're getting the distribution.
That's why the price dropped this morning. Shares sold at 8pm yesterday carried the distribution with them, shares sold at 5am today did not.

This is a subtle point, but a capital gains distribution, especially a long term CG distribution, is not exactly the same as a dividend. For a short seller, it's similar in that you get paid cash if you're long across the ex-date and you owe that cash if you're short going into the ex-date. However, with dividends there are clear tax rules for how to account for that short dividend cost - either you add it to your basis in the short position (if the short was held 45 days or less) or you get it as an itemizeable deduction in the current year (if you hold it longer than 45 days).

Does anyone have any idea what the tax situation will be for OP having shorted a CG distribution? I've wondered about this and never seen a good answer. What about the difference between long term CG's and short term ones, or being short tax-free distributions? Inquiring minds want to know .

On further reflection:

The rules about deducting/capitalizing payments in lieu of dividends on short positions are in sec. 263(h). Sec. 263 in general has the rules about capitalization, prohibiting deductions for items that are "chargeable to capital account." Therefore, if these rules don't apply (and no others do), then payments in lieu should simply be deductible. (That was the rule before this rule was enacted in 1984.)

Sec. 263(h), by its terms, applies only to "dividends" on "stock." (In contrast, sec. 263(g), which requires capitalization of interest and carrying charges on straddles, applies to any payments on straddles with respect to any personal property.) "Stock," in tax terms, is only the equity in a "corporation" (in tax terms).

Now, there are several different ways an ETF can be organized for tax purposes. The most common is as a regulated investment company, which is the form used for most mutual funds (including closed-end funds and unit investment trusts). RIC's are corporations which just happen to be subject to special rules, including most importantly the dividends paid deduction (so that they don't pay regular income tax as long as they distribute their full income). Sec. 854 says that RICs' capital gain dividends are not "dividends," but only for purposes of individuals' qualified dividend special rate and corporate holders' dividends received deductions; and that only the pass-thru fraction of other dividends are dividends, again for purposes of those sections only. Therefore, both capital gains and ordinary RIC dividends should be "dividends" for purposes of sec. 263(h), so the same rule should apply. But sec. 852(b)(5)(B) says that exempt-interest dividends are to be treated as tax-exempt income "for all purposes of this subtitle," i.e., all income tax purposes, so that payments you make in lieu of those should be simply deductible regardless of your holding period.

If it's a grantor trust or some other kind of disregarded entity, then when you short it, it's as if you shorted all of its holdings. So, if they are stocks, then the same rule should apply -- assuming that the payment is in fact in lieu of those dividends; if the cash instead gets accumulated, there might not be a similar payment to which the rule would apply.

If the ETF is instead a partnership, its shares won't be "stock" and its distributions won't be "dividends." But, while it's unclear, I think it's likely that the partnership should be looked through to its holdings, so that, to the extent the distributions correspond to dividends received by the partnership, the payments in lieu should be treated the same way.

If you have a partnership or grantor trust holding something other than stock, then the rule should NOT apply, and payments you make should just be deductible.