Client hands me a two sentence article cut from "Bottom Line/ Personal" advising that one can sell a stock, take the loss, and buy it back in their IRA with no concern for wash sale rules. I find little definitive comment on this. Fairmark has a brief article saying this likely would get bounced under audit, and I tend to agree, given the rest of the IRS regs on this matter, that even buying in someone else's account within a family can be considered a violation of wash rules. Anyone have any better references on this?
Did Bottom Line include a Circular 230 Notice...? =)
-Tad
IRS CIRCULAR 230 NOTICE: To the extent that this message or any attachment concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
As I'm sure you know from similar threads over at misc.taxes.moderated, the IRS hasn't provided any rulings on this and apparently no court has decided the case. As I understand it, it is usually to the IRS's benefit to not go out on a limb one way or the other.
My vote would be with Ed Zollars: "[...] there is some risk that the IRS could disallow any loss. But there is enough support that I would accept signing a return. As well, there is likely a low risk that the IRS would even become aware of the issue unless you flaunted the position."
As a financial planning issue, I sense there might be some small benefit but I'm not sure how to nail it down. Wash sale rules are essentially tax-neutral, in that they simply prevent you from realizing in an unrealized loss -- you have to wait until you sell the asset "for good" before you recognize the loss (or gain). So, the only time an unrestricted wash sale would really help you is if you expect your future tax rate to be lower, so you want to use the loss now to offset income in a higher bracket.
But wait -- that's just what a traditional IRA is for (deferring current income with the expectation of lower rates in the future). The other issue, whether to hold a particular asset in an after-tax vs. pre-tax account has also been discussed here thoroughly.
Hmm, I suppose it would be a nice trick if taking the loss in the current year was the thing that lowered your AGI enough to allow a deduction for your contribution to an IRA (due to being covered by an employer plan).
Ignoring the legality for the moment, there really is a benefit here. The tax treatment of any funds in the IRA is already effectively pre-ordained in that not many things you do now within the IRA will have any known effect on taxes upon distribution (barring actions that incur penalties, of course). But the tax loss harvested by selling a losing security might be used to offset ordinary income, assuming little or no other capital gains, thus saving taxes at your marginal tax rate. The gains on the reinvested taxable proceeds (in a different security) might be taxed at a lower capital gains rate in the future. This is really no different than what was stated in the quoted text above, except that the likelihood of having a higher "bracket" (i.e. ordinary income vs. capital gains) now may be higher than is thought at first glance.
I did see the MTM threads and I agree that the IRS hasn't been clear in this. I do have a scenario where following the letter of the law (i.e. conservatively accepting that an IRA purchase invokes wash rules) would benefit the client.
Doubtless, there are still people who have dotcom bubble stocks they haven't sold, and if they did, they'd have losses that would carry forward for years. Say they also have a fully deducted (i.e. all pretax) IRA, worth $200K. They sell 1000 shares of a stock purchased at $100 (I'm thinking CSCO) and buy it in their IRA at today's $30. The $70,000 loss is 'washed' and the only way I can see to account for it is to assign a basis within the IRA for $70,000. If sold, a bit later, the loss within the IRA doesn't get spit out of the account, it stays as basis. Client uses this approach until the basis within the IRA is close to the IRA's current value. At that point, they can convert this to a Roth with no tax due.
I'm thinking this approach suitable to that group of people who have large losses that they will never be able to take, $3000/yr against ordinary income is little use against $100Ks of losses. I agree with your assessment that much of the wash rule is tax-neutral, I believe this type of scenario can capture losses that may never be taken.
Any fault with how I claim the IRA can have its basis raised by this method? How else would the washed loss be reconciled upon sale within the IRA?
There's the rub. My reading of the Fairmark article seems to indicate that just like a related-party sale, the deduction for the loss is lost forever, there is no way to make it up (it does not get added as basis). As a practical matter, nowhere on Form 8606 (Non-deductible IRAs) does it allow you to adjust the basis for a wash sale, only for your nondeductible contributions.
Once again I am awed by the creative thinking that goes on in this group sometimes! Unlike most, who would want to disregard wash sales rules for this type of transaction and take the capital loss, you want to actually use the wash sale rules to effectively turn what would be ordinary income from an IRA distribution (Roth conversion) into the equivalent of a long-term capital gain to be offset against a long term capital loss masquerading as a nondeductible IRA basis. IMHO this has much more risk of being audited and disallowed than the the "disregard wash sale" approach -- it's too much like double-dipping, in other words trying to get capital gains treatment and retirement plan treatment for the same income.
But, for the dollar amounts you mentioned, might as well "go for it with full disclosure" as someone over in misc.taxes.moderated put it, and help get the final answer for all of us! ;-)
You're misunderstanding the concept of IRA "basis". It's not the cost basis of the investments within the IRA, it's the total of nondedutible contributions to the IRA (including those that occured in a qualified plan that was moved to a rollover IRA).
I think I did worse than that, I think that, as Mark indicated, it's a matter of the loss going away completely as a related party transaction. "Indirect transactions: You cannot deduct your loss on the sale of stock through your broker if, under a prearranged plan, a related party buys the same stock you had owned. This does not apply to a trade between related parties through an exchange that is purely coincidental and is not prearranged" not a matter of trying to understand how to reassign the loss within the IRA buying the stock. JOE
Or an impetus to withdraw the asset (security), not its value, when taking a distribution. Then perhaps you could add the earlier washed loss to the basis (the value at the time of distribution), as intended by the wash sale rule.
IMHO, the idea of increasing the "basis" of the security purchased within the IRA is not feasible. If the security were sold within the IRA and the proceeds were distributed (withdrawn), the custodian of the IRA will file a 1099-R which states the net proceeds -- that is, the FMV less transaction fees. There simply is no opportunity to reduce the proceeds by the earlier washed loss based on some theory of increased "basis".
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