Question

Sam owns 1,500 shares of Eagle, Inc. stock that he purchased over 10 years ago for $80,000. Although the stock has a current market value of $52,000, Sam still views the stock as 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 immediately after selling the shares he currently owns. Evaluate Sam’s treatment of these stock transactions. Can his plan work?

Answer 1

Answer :-

Section 1091 stipulates that in certain cases, a realized loss on the sale or exchange of stock or securities is not recognized. Specifically, if a taxpayer sells or exchanges stock or securities and within 30 days before or after the date of the sale or exchange acquires substantially identical stock or securities, any loss realized from the sale or exchange is not recognized because the transaction is a wash sale. Recognition of the loss is disallowed because the taxpayer is considered to be in substantially the same economic position after the sale and repurchase as before. This disallowance rule does not apply to taxpayers engaged in the business of buying and selling securities.

Attempts to avoid the application of the wash sale rules by having a related taxpayer repurchase the securities have been unsuccessful. The wash sale provisions do not apply to gains.

Unfortunately, Sam's plan will not work. As you might expect, the IRS has already thought about this. In Rev.Rul. 2008–5 (2008–1 C.B. 271), the IRS indicated that § 1091 disallows a deduction for the loss recognized by the individual on the sale. Further, the IRS ruled that the individual's basis in the IRA is not increased by reason of §1091(d). So Sam has effectively lost (wasted) his $28,000 loss.

The ruling relies on Security First National Bank of Los Angeles, 28 BTA 289 (1933), which considered a wash sale involving a grantor trust controlled by the taxpayer. The IRS reasoned that even though the IRA is a tax-exempt trust, the individual should be treated as having acquired the newly purchased securities to prevent "easy evasion" of § 1091. Thus, the ruling constitutes a significant extension of the holding in Security First.

Although the ruling speaks only to IRAs, one can assume that the logic would also apply to a § 401(k) plan. Another Twist: At the end of the ruling, the IRS says that its ruling does not address issues under § 4975. The reference to the prohibited transaction rules is worth noting. If an IRA engages in a § 4975 prohibited transaction, it loses qualification under § 408(e)(2). That makes everything in the IRA, not just the transaction amount, immediately taxable. However, it is likely that the IRS is merely deferring to the Department of Labor, which has jurisdiction over the § 4975 rules that apply to IRAs. On the other hand, it is just one more reason taxpayers should not engage in wash sales with an IRA as purchaser of replacement securities.