Bed And Breakfast Deal

In the United Kingdom, the practice 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. Arrangements are made between the holder of the security and the broker to accommodate the sale and repurchase.

A bed and breakfast deal is carried out to maintain an investment portfolio while minimizing UK capital gains taxes. Positions are closed out at the end of the year and immediately reopened on the first day of the new financial year in order to take advantage of the annual exemption. Because this practice intentionally seeks to limit capital gains taxes, tax authorities worked hard to minimize the occurrence of bed and breakfast deals and finally effectively banned the practice with the 30-Day Rule in 1998.

Traditional "bed and breakfasting" is no longer possible in its simplest form; a trader must now wait 31 days before buying shares back, which is fine for Capital Gains Tax planning purposes, but this does not always appeal to those who wish to stay in the market.

There is a way to effectively replicate a bed and breakfast deal with a little foresight. Let's assume an investor bought 10,000 shares of XYZ Group six months ago at £3.50 and the share price of XYZ Group is currently £3.00. You call up your regular stockbroker and sell the shares at £3.00 so 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.

Assuming an interest rate of 5 percent, per annum; this corresponds to £4.11 a day which adds up to £127.40 for 31 days. After 31 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 & Breakfast deal is now completed – albeit, with a bit more time and risk involved.

CFDs have allowed you to stay in the market regardless of the market direction. If the share price rises within the 31 day period, then profits will be built up on the CFD trade to offset re-buying the shares at a high 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.