Question

Joe owns 1,500 shares of Eagle, Inc. stock that he purchased over ten years ago for $80,000. Although the stock has a current market value of $52,000, same still views the stock as being a solid long-term investment. He has sold other stock during the year with overall gains of $30,000, so he would like to sell the Eagle stock and offset the $28,000 loss against these gains - but somehow keep his Eagle investment. He has devised a plan to keep his Eagle investment by using funds in his traditional IRA to purchase 1,500 Eagle shares immediatly after selling the shares he currnetly owns.

If Joe is your tax client and he comes to you with this idea, how would you advise him? Why?

Answer 1

When shares of a stock are sold and repurchased or acquired the same stock within 30 days (before or after) of the sale, it is known as a wash sale transaction.

Any loss form wash sale transaction cannot be used to offset gains on taxes for the year.This rule is to prevent investors from cliaming a tax deduction on a loss on property that is still owned and stops the artificial basis adjustment.

Fortunately, even if the wash-sale rule is triggered , assessee doesn't lose the tax deduction permanently. Instead, if wash-sale rule is triggered , the tax basis of the shares purchased is increased by the amount of the disallowed loss. When those shares are sold at a future date, assessee benefits from that higher basis, either by a larger capital loss or by reducing any capital gain that is earned in the interim.

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.

It is important to understand that wash-sale rules apply across accounts at different financial institutions as well as to different types of accounts.That is if you sell shares in your taxable account and buy substantially identical shares in your IRA within 30 days, the wash sale rule applies. It also applies if you sell shares in your taxable account and buy within 30 days financial instruments that can convert into the sold shares. Such instruments include convertible bonds, convertible preferred stock, warrants and options.

If the assessee breaks the above rule in order to reduce the current tax liability, deferred tax liability arises and the assessee may have to pay the penalty on the amount.

Considering the above all factors, Joe is advised not to sell the share and repurchase in IRA within 30 days as it would attract wash rule and the loss of $28,000 will not be available for set off against gains of $30,000.