Case study: preserving tax losses by avoiding the wash-sale rules.

• Author: Ellentuck, Albert B.

A TAXPAYER CANNOT DEDUCT THE LOSS realized on the sale of stock or securities (including shares in a mutual fund) if the taxpayer purchases substantially identical stock or securities within the period beginning 30 days before and ending 30 days after the sale (Sec. 1091(a)). The wash-sale rules apply to stock, securities, options, and short sales, but they do not apply to transactions involving foreign currency and commodities futures contracts (Rev. Ruls. 71-568 and 74-218). They apply whether the taxpayer voluntarily or involuntarily disposes of the stock or securities. Thus, the taxpayer must be careful when replacing stock that he or she sold at a loss.

Observation: At first glance, the Sec. 1091 wash-sale rules appear to prevent a taxpayer from ever recognizing a loss when the taxpayer sells shares within 30 days of purchase. Fortunately, Rev. Rul. 56-602 provides that Sec. 1091 is not intended to apply to bona fide sales made to reduce a taxpayer's holdings of the stock or security. Thus, a taxpayer who buys 200 shares of a stock and within the next 30 days sells 100 shares at a loss will not have the loss disallowed under the wash-sale rules. However, the rules will apply if the taxpayer acquires additional shares within the 30 days following the sale at a loss.

For the wash-sale rules to apply, the stocks or securities must be substantially identical. Ordinarily, stocks or securities of one corporation are not considered substantially identical to stocks or securities of another corporation.

Related Parties

Some taxpayers have tried to circumvent the wash-sale rules by having a related party purchase the replacement stock or securities. Although Sec. 1091 and the regulations do not apply to related parties, the courts generally have not allowed the loss in these situations (Sboenberg, 77 E2d 446 (8th Cir. 1935)). Also, where a taxpayer sells an asset at a loss, and his or her IRA purchases an identical asset within the Sec. 1091 time limits, the purchase by the IRA will be treated as a purchase by the taxpayer and the loss will be disallowed (Rev. Rul. 2008-5).

Taxpayers must also be aware of the Sec. 267 related-party transaction rules. The courts have ruled that the replacement was part of the original plan or, in some cases, that the sale by one taxpayer and the purchase by a related taxpayer should be collapsed into a single related-party transaction, resulting in loss dis-allowance under Sec. 267 (McWilliams, 331 U.S. 694...