Getting Around the Wash-Sale Rule

[ERICOPOLY]

22 minutes ago, lnofeisone said:

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).

 

 

What are you talking about?  What covered call?  You are buying calls, not shorting them.

[lnofeisone]

From earlier post:

 

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

 

 

If you do (1 and 2) that's selling a covered call. If you do (3 and 4) that's buying a covered call. In either case you are except from loss deferral. 

[ERICOPOLY]

9 minutes ago, lnofeisone said:

From earlier post:

 

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

 

 

If you do (1 and 2) that's selling a covered call. If you do (3 and 4) that's buying a covered call. In either case you are except from loss deferral. 

 

Neither case is a covered call.

[ERICOPOLY]

A covered call is one short position paired with one long position.

 

You are presenting two long positions in both scenarios.

[lnofeisone]

A covered call is one short position (sell stock at loss - step 1 above) paired with one long position (buy a call - step 2 above).

 

How do you view this as a long position? 

[ERICOPOLY]

Just now, lnofeisone said:

A covered call is one short position (sell stock at loss - step 1 above) paired with one long position (buy a call - step 2 above).

 

How do you view this as a long position? 

You have a long position that you sell which washes against the long position that you buy.

 

 

A covered call would be:

Buy stock for $10 and write $12 strike call option.  There are NOT two long positions here.

[lnofeisone]

I think I see the disconnect.

 

Sell: 300 shares

Buy: 3 calls

 

You view this as sell 3 covered calls.

 

Start: 1,000 shares

Sell: 300 shares

Buy: 3 calls

 

You don't view this as start with 1,000 shares and sell 3 covered calls?

 

[ERICOPOLY]

1 minute ago, lnofeisone said:

I think I see the disconnect.

 

Sell: 300 shares

Buy: 3 calls

 

You view this as sell 3 covered calls.

 

Start: 1,000 shares

Sell: 300 shares

Buy: 3 calls

 

You don't view this as start with 1,000 shares and sell 3 covered calls?

 

 

1). Sell 300 shares and buy 3 calls

You start off net short 300 shares and later take a long position of 3 calls if I understand you correctly.  This isn't a "covered call" but it is a covered short stock position and may fall under the same rules that you referenced earlier regarding covered calls.

 

2).  Start 1,000 shares, next sell the shares, next by 3 calls

You sold 300 shares that you owned already.  Then you bought 3 calls.  There is no covered call here.

 

 

 

 

 

 

 

 

[lnofeisone]

1 minute ago, ERICOPOLY said:

2).  Start 1,000 shares, next sell the shares, next by 3 calls

You sold 300 shares that you owned already.  Then you bought 3 calls.  There is no covered call here.

That's what I thought the issues is. The end result is that there is no covered call (that's the position you are arguing and I agree). What I am saying is that the transaction that had to occur to get me from 1,000 shares to 700 shares + 3 calls is mathematically equivalent to selling covered calls. Now if you go to my original example:

 

You would start with 1,000 shares. 

1) You would sell all your shares

2) You would buy equivalent amount of calls 

 

The net result is that you have no covered calls ad you are net long 10 calls. The transaction to get you there was a sale of 10 of covered calls. That's how IRS views it. This is the very likely reason the Deloitte partner has recommended that as an approach. So in order of operations:

 

0) I bought 1,000 shares

1) I sold 1,000 shares --> I can take a loss

2) I bought identical instrument, e.g., deep ITM calls --> I now can't take a loss as I triggered a wash sale. The call basis is now stepped up

3) I bought 1,000 shares --> these shares are not related and are not impacted by what I did in 0, 1, or 2. The cost basis of these shares are not stepped up. 

4) I sell the calls --> I can now take the loss on the calls with stepped up basis

[ERICOPOLY]

Your garden variety wash sale goes like this:

 

1.  Purchase stock

2.  Sell stock at a loss

3.  Replace the prior long position within 30 days.

 

It is immaterial that you draw a sharpie through the first step because the first step did in fact occur.

 

 

 

Edited October 12, 2021 by ERICOPOLY

[ERICOPOLY]

31 minutes ago, lnofeisone said:

0) I bought 1,000 shares

1) I sold 1,000 shares --> I can take a loss

2) I bought identical instrument, e.g., deep ITM calls --> I now can't take a loss as I triggered a wash sale. The call basis is now stepped up

3) I bought 1,000 shares --> these shares are not related and are not impacted by what I did in 0, 1, or 2. The cost basis of these shares are not stepped up. 

4) I sell the calls --> I can now take the loss on the calls with stepped up basis

 

You can take the loss in 4 only if it falls greater than 30 days past the purchase of 1,000 shares made in step 3.

 

That is what I was saying in the beginning.   That leaves you stuck with being "doubled down" for 30 days.

 

Edited October 12, 2021 by ERICOPOLY

[ERICOPOLY]

32 minutes ago, lnofeisone said:

3) I bought 1,000 shares --> these shares are not related and are not impacted by what I did in 0, 1, or 2. The cost basis of these shares are not stepped up. 

4) I sell the calls --> I can now take the loss on the calls with stepped up basis

 

That is "mathematically equivalent" to selling for a loss less than 30 days after buying the replacement shares.

 

That's a wash sale.

 

[lnofeisone]

This is not a garden variety transaction. So a "garden variety" wash sale rule doesn't apply. The IRS publication (the very thing that you can point to when you get examined) say so. A tax partner say so. An opinion (albeit logical but the tax code is not a logical being) on a message board gets weighted appropriately.

 

I'm going to drop this because it's a waste of time for me to walk in circles while there is no new information that disputes the IRS publication and the link I provided.

[Spekulatius]

10 hours ago, lnofeisone said:

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. 

 

 

@lnofeisone thanks for sharing. To me, your method makes sense. The end result is the same than a wash sale, but the IRS tax code has build in a path dependence (via effectively selling a covered call) which is exploited to materialize a tax loss.

 

Is there any timeline in which steps 2-4 need to occur? Can you just execute those the same day?

Edited October 12, 2021 by Spekulatius

[johnpane]

"A qualified covered call option is any option you grant to purchase stock you hold." (Source: 2020 Publication 550, page 60)

 

The publication equates writing and granting, e.g., "Writer of option. If you write (grant) an option, ..." (p. 57).

 

Step (4) in your scenario is selling a call you have purchased, not writing one. If you deem yourself to have written an option, the one you acquired in step (2) is not closed and you cannot take the loss.

 

[lnofeisone]

1 hour ago, johnpane said:

Step (4) in your scenario is selling a call you have purchased, not writing one. If you deem yourself to have written an option, the one you acquired in step (2) is not closed and you cannot take the loss.

 

Ok - deem yourself to have closed an option in step (2) and take the loss. The 2nd lot of shares is still untouched by the wash sale and basis step up doesn't apply. 

[ERICOPOLY]

2 hours ago, Spekulatius said:

@lnofeisone thanks for sharing. To me, your method makes sense.

 

The IRS excuses a covered call situation because the call that is written exposes you to unlimited losses.  No reasonable person could believe that this short call position which exposes you to unlimited upside losses is a material replacement for your prior long shares that you have sold.

 

None of the examples presented thus far are covered calls.  They are ALL wash sales.

 

 

 

[ERICOPOLY]

1 hour ago, johnpane said:

"A qualified covered call option is any option you grant to purchase stock you hold." (Source: 2020 Publication 550, page 60)

 

The publication equates writing and granting, e.g., "Writer of option. If you write (grant) an option, ..." (p. 57).

 

Step (4) in your scenario is selling a call you have purchased, not writing one. If you deem yourself to have written an option, the one you acquired in step (2) is not closed and you cannot take the loss.

 

 

I agree with this and you raise a key point:  "If you deem yourself to have written an option, the one you acquired in step (2) is not closed and you cannot take the loss."

[ERICOPOLY]

1 hour ago, lnofeisone said:

Ok - deem yourself to have closed an option in step (2) and take the loss. The 2nd lot of shares is still untouched by the wash sale and basis step up doesn't apply. 

 

You are referring to "the wash sale".  That is the FIRST wash sale.

 

The SECOND wash sale is the subject of interest.  It is created when the calls with the adjusted basis from the first wash sale are in turn sold because a new slug of shares have been purchased within 30 days.

[lnofeisone]

 

 

Ok - here is the key premise that I think is missing: "Selling a call and buying a stock doesn't trigger a wash sale.

 

Here is another para from IRS code on matching your first shares that would be sold to a purchase of calls:

 

"More or less stock bought than sold. If the number of shares of substantially identical stock or securities you buy within 30 days before or after the sale is either more or less than the number of shares you sold, you must determine the particular shares to which the wash sale rules apply. You do this by matching the shares bought with an equal number of the shares sold. Match the shares bought in the same order that you bought them, beginning with the first shares bought. The shares or securities so matched are subject to the wash sale rules"

 

So if you have 1,000 shares and sell them and then buy 10 calls - that's matched and wash sale applies to that, i.e., if you hold the calls, you have to defer the loss until you sell the calls. Agreed.

 

The next purchase of 1,000 shares is not matched to anything. You effectively doubled down because these are not offsetting positions and wash sale rule is not triggered (you are long 10 calls, long 1,000). You then sell the calls. This sale becomes covered call sale and  this paragraph of the code applies. Note it says absolutely nothing about what kind of calls they are, when they were purchased, look forward/backward periods, or how you arrived at the cost basis. It also says absolutely nothing about you needing to be a -10 calls + 1,000 shares to have a qualifying covered call transaction (not position). 

 

"Capital loss on qualified covered call options. If you hold stock and you write a qualified covered call option on that stock with a strike price less than the applicable stock price, treat any loss from the option as long-term capital loss if, at the time the loss was realized, gain on the sale or exchange of the stock would be treated as long-term capital gain. The holding period of the stock does not include any period during which you are the writer of the option." --> "Selling a call and buying a stock doesn't trigger a wash sale.

 

Honestly, show me one example, that is not your opinion or interpretation of the IRS Code, of a direct example from IRS Code or, at this point, anywhere on the web that agrees with your position on double wash rule with a pathway I laid out. The light search I've done only shows a single transactions and (as Spek succinctly put it) doesn't consider a path dependency (which I believe IRS didn't consider when writing this reg). 

 

Edited for clarity.

Edited October 12, 2021 by lnofeisone

[ERICOPOLY]

show me one example, that is not your opinion or interpretation of the IRS Code

 

What will matter at your IRS audit is a piece of paper that you can reference as the IRS's opinion.  So present your scenario to the IRS and ask them for an official opinion.  That's what will matter.

 

 

[Spekulatius]

Simulate the transaction sequence in Turbotax and if you get a the right result, you should be good to go. That would be my poor mans legal opinion.

[lnofeisone]

59 minutes ago, ERICOPOLY said:

show me one example, that is not your opinion or interpretation of the IRS Code

 

What will matter at your IRS audit is a piece of paper that you can reference as the IRS's opinion.  So present your scenario to the IRS and ask them for an official opinion.  That's what will matter.

 

 

The piece of paper you are referencing is called a Private Letter Ruling (and you don't need it to to deal with IRS - just ask Peter Thiel). PLR will likely cost you $38k in IRS fees alone and multiples of this in attorney fees. I can give you a few recs, if you are interested. I'm not that vested into this argument. 

 

[ERICOPOLY]

24 minutes ago, lnofeisone said:

The piece of paper you are referencing is called a Private Letter Ruling (and you don't need it to to deal with IRS - just ask Peter Thiel). PLR will likely cost you $38k in IRS fees alone and multiples of this in attorney fees. I can give you a few recs, if you are interested. I'm not that vested into this argument. 

 

 

I'm quite confident that selling a share is not selling a call.  But thank you for the offer of recs, I respectfully decline.

[johnpane]

Selling a call you hold is not "writing a call", thus not "writing a covered call", thus not "writing a qualified covered call". Your whole argument rests on a section of Pub 550 that does not apply to the situation.