Getting Around the Wash-Sale Rule

[MVP444300]

Possible work around to the wash-sale rule- sell a stock in a taxable account at a loss for tax-loss harvesting and then immediately buy it back in an IRA without incurring the wash-sale rule.

 

Does anyone know if this is legit?

 

https://money.cnn.com/2000/12/14/pensions/q_retire_slott/

 

How do I know this? The IRS informal position from an IRS e-mail response to this very question says so, and based on their explanation I now agree that it can be done and the wash-sale rule does not apply when the stock is bought back in the IRA. �
 

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The IRS considers the sale of the stock in your taxable account and the repurchase of it in your IRA "two unrelated transactions." When you buy the stock back in your taxable account you create "basis," which at some point when you later sell that stock, will allow to reduce the gain or claim a loss.

When you buy the stock back in your IRA, you do not create basis, because all distributions (other than distributions of nondeductible IRA contributions) from that IRA will be fully taxable regardless of how much the stock was purchased for within the IRA.

 

 

[Spekulatius]

This above article is dated (year 2000) and incorrect. The wash sale rule does apply to IR purchases buy/sells of the same security in taxable/IRA‘s are not deemed unrelated.

https://www.investopedia.com/articles/retirement/09/ira-wash-sale-rule.asp

 

 

Does the Rule Apply to IRAs? 

In 2008, the IRS issued "Revenue Ruling 2008-5," in which it addressed the question of whether the wash-sale rules apply to IRAs. In the ruling, the IRS explained that when shares are sold in a non-retirement account and substantially identical shares are purchased in an IRA within 30 days, the investor cannot claim tax losses for the sale, and the basis in the individual's IRA is not increased.2

 

Edited October 9, 2021 by Spekulatius

[MVP444300]

Shoot I didn't even pay attention to the date of the article.   I was hoping this article was still correct.   Thank you for clarifying

[MVP444300]

By the way, are there any other ways to get around the wash-sale rule?   I have a stock that has dropped dramatically since I purchased it but I believe the company has good long term potential.    I want to take advantage of the loss while still holding on to the shares at these low prices and in fact I am thinking of buying more.   If anyone knows of a way please let me know.

[thepupil]

you'r in luck in that it's october, so as long as it fits w/i your risk tolerance, the simplest thing to do is 

 

buy more on October 11th

Sell your specific high cost basis shares on November 12th or later, realizing a loss. 

 

bonus step: buy more December 13th or later once the procrastinators start tax loss selling

additional nuance: if you can, try to double down in your tax deferred account, so your high basis shares on in your taxable and low basis are in your IRA

 

for 30 days you'll be doubly exposed. If this is too much risk or you feel that you're letting the tax tail wag the investment dog, then you could double down, but also do a collar (on half the shares) to reduce risk (such as sell a 20% OTM call and buy a 30% OTM put. to avoid constructive sale, I recommend a pretty wide band on the collar

https://www.nysscpa.org/news/publications/the-trusted-professional/article/tools-techniques-to-shield-and-defer-taxes-on-unrealized-stock-gains

Quote

Most tax practitioners are of the view that the constructive sale rules promulgated as IRC section 1259 pursuant to the Taxpayer Relief Act of 1997 (the “constructive sale rules”) require that a collar have at least a 15% band around the current price of the stock, as per an example in the legislative history to the statute. In the example above, Investor C was able to achieve the requisite 15% band while implementing a cashless collar.

 

Edited October 9, 2021 by thepupil

[MVP444300]

Thank you for the recommendation Pupil

[lnofeisone]

On 10/8/2021 at 11:44 PM, MVP444300 said:

By the way, are there any other ways to get around the wash-sale rule?   I have a stock that has dropped dramatically since I purchased it but I believe the company has good long term potential.    I want to take advantage of the loss while still holding on to the shares at these low prices and in fact I am thinking of buying more.   If anyone knows of a way please let me know.

The strategy pupil is describing is called doubling down. There is another strategy (this isn't a recommendation, please verify with your CPA and do your homework ) 

1) Sell your stock at a loss (say you lost $10/share)

2) Buy a call option - you can buy a deep in the money call (say, $15). You have now triggered a washsale. Meaning you can't take a loss on your stock but your cost basis for the call has gone up to $25/share. 

3) Buy your stock back

4) Sell the call at a loss

 

This is a way to keep your shares and keeping your loss. The biggest disadvantage of this strategy is matching your tax rate (i.e., it's not idea if you held a stock for more than a year).

[Spekulatius]

I typically just do a dirty hedge - sell the loss position and buy a similar security or a correlated ETF and hold it for a month, then switch back I to the stock if you still desire.

[ERICOPOLY]

Naked shorting used to be a way around it because capital gains were only realized when delivery happened. 

 

I wonder if paranoid minds took it the wrong way when I think back upon the Patrick Byrne saga.

[ERICOPOLY]

7 hours ago, ERICOPOLY said:

Naked shorting used to be a way around it because capital gains were only realized when delivery happened. 

 

I wonder if paranoid minds took it the wrong way when I think back upon the Patrick Byrne saga.

 

Clarifying (because I wrote that wrong), I believe that initially you could still short against the box without it being a constructive sale as long as you never delivered the shares, and therefore avoiding the capital gains tax by naked shorting.

[Mephistopheles]

On 10/10/2021 at 6:49 AM, lnofeisone said:

The strategy pupil is describing is called doubling down. There is another strategy (this isn't a recommendation, please verify with your CPA and do your homework ) 

1) Sell your stock at a loss (say you lost $10/share)

2) Buy a call option - you can buy a deep in the money call (say, $15). You have now triggered a washsale. Meaning you can't take a loss on your stock but your cost basis for the call has gone up to $25/share. 

3) Buy your stock back

4) Sell the call at a loss

 

This is a way to keep your shares and keeping your loss. The biggest disadvantage of this strategy is matching your tax rate (i.e., it's not idea if you held a stock for more than a year).

 

In this situation, you're taking a loss on the call while still having the stock, and if it's all within 30 days then it would still be a wash sale, no?

[ERICOPOLY]

2 hours ago, Mephistopheles said:

 

In this situation, you're taking a loss on the call while still having the stock, and if it's all within 30 days then it would still be a wash sale, no?

 

Yes you'd have to wait the 30 days after buying the stock back before you can sell the call for a loss.  AKA:  doubling down.

[lnofeisone]

4 hours ago, Mephistopheles said:

 

In this situation, you're taking a loss on the call while still having the stock, and if it's all within 30 days then it would still be a wash sale, no?

No. The shares you are holding now, if you match them exactly to your options (so say you have 300 shares that you sell and you buy 3 calls), that's a wash sale. Once you sell your calls, you get your loss. 

 

Buying a new lot of shares doesn't tie your new shares to your old shares. Your calls have already done that. This is almost the same as doubling down. 

 

There is nothing in the IRS docs that I've seen that contradicts this. If anyone knows, do let me know. If you want, try simulating this transaction in the TurboTax and see what happens. Does this violate the letter of the law, likely not. Spirit of the law, absolutely. But you did ask how to avoid a wash sale rule .

[ERICOPOLY]

"Buying a new lot of shares doesn't tie your new shares to your old shares. "

 

1.  When you buy the new shares, they are not yet tied to the old shares or to the calls (which are tied to the old shares).  

2.  When you sell your calls, the question will be asked "have you purchased within 30 days?"  The answer to this question will be YES, so a new wash sale is created and the cost basis of your second slug of shares is adjusted..

Edited October 11, 2021 by ERICOPOLY

[lnofeisone]

Do you have any 

3 minutes ago, ERICOPOLY said:

"Buying a new lot of shares doesn't tie your new shares to your old shares. "

 

1.  When you buy the new shares, they are not yet tied to the old shares or to the calls (which are tied to the old shares).  

2.  When you sell your calls, the question will be asked "have you purchased within 30 days?"  The answer to this question will be YES, so a new wash sale is created and the cost basis of your second slug of shares is adjusted..

Do you have any IRS publications to back this up? I have never heard of wash sale rules have transitive properties like that. 

[ERICOPOLY]

30 day rule also looks back thirty days.  It's not merely forward looking.

 

Otherwise you could have foregone the calls altogether and doubled down on shares for a microsecond (or a day) before selling the original shares at a loss.

 

Edited October 11, 2021 by ERICOPOLY

[ERICOPOLY]

https://www.fool.com/investing/how-to-invest/stocks/stock-wash-sale-rule/#:~:text=Under the wash-sale rules,selling your longer-held shares.

 

Under the wash-sale rules, a wash sale happens when you sell a stock or security for a loss and either buy it back within 30 days after the loss-sale date or "pre-rebuy" shares within 30 days before selling your longer-held shares.

[lnofeisone]

No. You need the calls to capture the loss and tied up your first lot to the calls. The question will be related to the calls (substantially identical security) and not the second lot. The fool.com article doesn't conflict with this.

[ERICOPOLY]

Just now, lnofeisone said:

No. You need the calls to capture the loss and tied up your first lot to the calls. The question will be related to the calls (substantially identical security) and not the second lot. The fool.com article doesn't conflict with this.

 

I'm saying the loss from selling the calls will be disallowed because you have purchased a substantially identical security within 30 days.  You have done exactly that, in your scenario:  you are trying to take a loss on the calls you sell despite the fact that you have purchased a substantially identical replacement lot of shares within 30 days.  That's a wash by definition.

[Mephistopheles]

9 minutes ago, lnofeisone said:

No. You need the calls to capture the loss and tied up your first lot to the calls. The question will be related to the calls (substantially identical security) and not the second lot. The fool.com article doesn't conflict with this.

 

The loss on the calls will be a wash sale since you would have bought the new shares within a 30 day period. The loss from the old shares get tied to the basis on the call. Then you buy the new shares and sell the call, and the loss on the call (including from the old shares) gets tied to the new shares. The 30 days is forward and backward looking.

[lnofeisone]

Does anyone have an official IRS Guidance they can provide? I've read that one a lot and never seen a transitive property that's being suggested. Also:

 

"However, the government states that the sale of an equity and the purchase of a call option on that equity does actually trigger a wash sale. Ironically selling a call for a loss and then buying the underlying stock does not." 

and

"

A partner at Deloitte suggested to us a three-step process to take a loss while not substantially disturbing alpha.

 

• Step 1: Sell XYZ for a $15 loss.
• Step 2: Buy the call option for $3.
• Step 3: Buy back the stock."

 

https://www.nasdaq.com/articles/strategies-help-clients-around-wash-sale-rule-2015-11-10

 

Edit for grammar and another pertinent paragraph.

Edited October 11, 2021 by lnofeisone

[johnpane]

44 minutes ago, lnofeisone said:

Buying a new lot of shares doesn't tie your new shares to your old shares. Your calls have already done that. This is almost the same as doubling down. 

 

This is the flaw in your thinking. The "tie" between the security sold at a loss and the purchased security is instantaneous, not lasting. The cost basis of the purchased security is increased and the "tie" is no longer present. Now the purchased security (calls in your case) with stepped up cost basis is completely "fresh" with respect to the wash sale rule. How it got its cost basis is not relevant. 

[lnofeisone]

52 minutes ago, johnpane said:

This is the flaw in your thinking. The "tie" between the security sold at a loss and the purchased security is instantaneous, not lasting. The cost basis of the purchased security is increased and the "tie" is no longer present. Now the purchased security (calls in your case) with stepped up cost basis is completely "fresh" with respect to the wash sale rule. How it got its cost basis is not relevant. 

@ERICOPOLY @Mephistopheles  I realize that it may feel intuitive and very logical to assume this but that's just not how the tax code is written. In essence, the second transaction creates a covered call and is excepted from loss deferral rules. Furthermore, the 2nd purchase doesn't constitute a successor position and thus not a wash sale by definition.

 

I guess the one addendum to the calls argument I would make is to make sure you have qualified covered calls.

 

 

Here is an actual IRS publication:

https://www.irs.gov/pub/irs-pdf/p550.pdf

Page 59 

 

"Exceptions. The loss deferral rules do not apply to: 1. Positions established after October 21, 2004, comprising an identified straddle; 2. Certain straddles consisting of qualified covered call options and the stock to be purchased under the options;"

 

The second purchase of a lot doesn't meet the requirement of a successor position as it fails to meet both requirements (page 60 - Successor Position). 

 

[ERICOPOLY]

2 hours ago, lnofeisone said:

@ERICOPOLY @Mephistopheles  I realize that it may feel intuitive and very logical to assume this but that's just not how the tax code is written. In essence, the second transaction creates a covered call and is excepted from loss deferral rules. Furthermore, the 2nd purchase doesn't constitute a successor position and thus not a wash sale by definition.

 

I guess the one addendum to the calls argument I would make is to make sure you have qualified covered calls.

 

 

Here is an actual IRS publication:

https://www.irs.gov/pub/irs-pdf/p550.pdf

Page 59 

 

"Exceptions. The loss deferral rules do not apply to: 1. Positions established after October 21, 2004, comprising an identified straddle; 2. Certain straddles consisting of qualified covered call options and the stock to be purchased under the options;"

 

The second purchase of a lot doesn't meet the requirement of a successor position as it fails to meet both requirements (page 60 - Successor Position). 

 

 

Buying calls does not create a covered call situation.  

 

You are holding stock for a loss and then you buy the calls.  That's not a covered call.  

 

To create a covered call, you own the stock and short the calls -- the short call is "covered" by the underlying stock that you hold.

Edited October 12, 2021 by ERICOPOLY

[lnofeisone]

Nice red herring there. That's why I said 1) sell the stock 2) buy the calls. Those two steps constitute a covered call transaction (sell side of it).

 

In either case, that transactions triggers a wash sale and subsequent purchases are fine. IRS publication provides 0 evidence to the contrary. A Deloitte partner says so. I'm open to evidence of the contrary.