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Wash sales using IRA


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17 replies to this topic

#1 nicola

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Posted 14 November 2005 - 05:03 PM

What if a taxpayer sells a security at a loss in his regular account (not an IRA account) but uses his tax-advantaged retirement account (IRA) to buy substantially identical securities within 30 days after the sale in his regular account, do the "wash sale" rules apply so that his capital loss would be limited?

Edited by nicola, 14 November 2005 - 05:05 PM.


#2 ElGuapo

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Posted 21 November 2005 - 02:59 AM

I don't see how the wash sale rules would apply. Kinda feels like you're getting away with something here though, huh? ;) But the IRA is really a different animal from a taxable investment in your name. You couldn't adjust the cost basis for the IRA shares because that term has no meaning within an IRA. I'm no CPA, though, so just speculating while we wait for a more authoritative reply. :unsure:

Edited by ty07480, 22 November 2005 - 12:48 AM.


#3 Demosthenes

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Posted 21 November 2005 - 08:06 AM

This is a related party sale and IMHO does constitute a wash sale, see

http://www.fairmark....ash/related.htm

"The tax law doesn't allow you to claim a loss when you sell stock (or anything else) to a family member, or to an entity controlled by you or your family (such as a corporation, partnership or trust). This rule may apply if you try to avoid the wash sale rule by purchasing replacement stock in an IRA, or having your spouse buy replacement property. The result can be worse than if the wash sale rule applied."


Section 9(a)(1)(A) and Rule 10b-5 of the Securities Exchange Act of 1934

For the purpose of creating a false or misleading appearance of active trading in any security registered on a national securities exchange, or a false or misleading appearance with respect to the market for any such security, (A) to effect any transaction in such security which involves no change in the beneficial ownership thereof

http://www.irs.gov/p...rs-pdf/p550.pdf

#4 nicola

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Posted 21 November 2005 - 06:38 PM

Thanks for your input. I could not find any "on point" regulation or court cases and I guess no one else could either. You would think that the IRS would specifically address this issue.

#5 ElGuapo

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Posted 22 November 2005 - 01:10 AM

This is a related party sale and IMHO does constitute a wash sale

Thanks for the link, very interesting reading. Not to mince words, but I guess the point is it's not a "wash sale" (which just delays the recognition of the loss) but actually a disallowed loss because it may be construed as an indirect sale to a related party. Hence the comment that "the result can be worse than if the wash sale rule applied."

Brings up a whole new set of questions, though, that this article didn't get into. Specifically, is it even safe then to buy replacement shares in the IRA after 31 days? I would hope so, given that IRA contributions must be cash. I mean, what if I owned shares with an unrecognized loss and I simply needed that money to make my annual contribution but didn't want to change investments? :blink:

#6 Guest_named_mjb_*

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Posted 22 November 2005 - 01:08 PM

Maybe the reason that the IRS hasn't issued a ruling on this issue is because there is no basis for applying the wash sale rule to a purchase by an IRA. Neither IRC 1091 or reg. 1.1091-1(a) extend the wash sale rule beyond the taxpayer who claims the loss. There are two reasons that the statute limits the wash sale rule to the same taxpayer who sells stock at a loss:

1. The requirement that the amount of the basis in the purchased stock be increased by the amount of the disallowed loss conflicts with IRS reg. 1.408-4 which requires that the basis in an IRA be zero.

2. Application of the wash sale rule does not result in a denial of the deduction to the taxpayer who purchases identical securities but merely defers the ability of the taxpayer to claim the loss until the wash sale period has expired which is why the same taxpayer is required to purchase the identical stock. In other words the taxpayer who engages in a wash sale does not lose the the tax loss. There is no transfer of the loss to another taxpayer who purchases the securites as would apply in the case of a related party transaction.

I do not see how the SEC regulation under insider trading for stock parking applies to this situation since the stock owned by the IRA for the benefit of the IRA owner will be registed in the name of the custodian as required by the securities laws which will be a change in beneficial ownership.

The only prohibition in this kind of sale are the PT rules which prevent the taxpayer from selling the shares directly to his IRA.

#7 Appleby

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Posted 23 November 2005 - 01:03 AM

mjb, if U R unable to log-in under your old username, please see below for an excerpt from a related e-mail from Dave Baker

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#8 traderatwork

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Posted 21 December 2005 - 06:10 PM

A light bulb blink on top of my head and say

"What if we long a deep in the money put in IRA and long a deep in the money call of the same underlying in RothIRA and actually we speculate the underlying to be going up so when we close the position one day IRA put option will lost money while your RothIRA call increase in value. If I can continue to do this with success I'll be able to withdraw from RothIRA tax free when we are 65 (damn IRS). Sound good to me. The 2 bad case scenario will be A.The stock doesn't move at all you lost time value in both contract. B. Your speculation is wrong and stock drop significantly and your IRA earned money and your RothIRA lost (which is ok, we still have the money just try next one)"

Sound like wash sale, but how IRS will rule it. Any thougt?

#9 Guest_named_mjb_*

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Posted 21 December 2005 - 06:32 PM

Do all traders talk this way? In order for readers to understand your question, it needs to be phrased in understandible english with explanations of trader talk, e.g. deep in the money put, etc.

#10 traderatwork

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Posted 21 December 2005 - 06:40 PM

Do all traders talk this way? In order for readers to understand your question, it needs to be phrased in understandible english with explanations of trader talk, e.g. deep in the money put, etc.



Ok, ok my bad.

Basically,
"Long a deep in the money call" = Long the stock = The stock price goes up is good
"Long a deep in the money put" = Short the stock = The stock price goes down is good

#11 Appleby

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Posted 22 December 2005 - 01:51 AM

Trader, you still need to explain further by using laymanís terms. For instance, instead of saying long, how about saying the client owns the stock-buys it with his own funds, and instead of saying selling short, say the client sold stocks that he does not own, i.e., he sold shares he borrowed from the brokerage house. Even then, I am not sure we would understand your comment unless you provide further elaboraion. The broker would need to determine whether such a transaction is allowed under the IRA agreement and most importantly, whether such a transaction could be considered a prohibited transaction

#12 WDIK

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Posted 22 December 2005 - 01:23 PM

You can search for many investment terms at this website.

Why can't everyone use understandable terms like "EGTRRA", "QNEC", "Standardized Safe Harbor Prototype", "Actuarial Equivalence", etc?


(Edited for typo)

Edited by WDIK, 23 December 2005 - 11:40 AM.

...but then again, What Do I Know?

#13 John G

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Posted 22 December 2005 - 10:41 PM

Don't ya just love these "its easy" and "get rich quick" schemes! I have periodically used options over the past 20 years and am always amazed why people are fascinated by them.

Options are designed for hedging and/or leverage. The average reader should not feel as if they are missing something if they don't know a put from a call, strangle from a straddle, or when to LEAP. If these terms are unfamiliar to you... then YOU MAY STOP READING AT THIS POINT and move to the next thread. The primary rule of investing is to understand your investments. A close second is to not get too greedy for abnormally high returns. Then there is that stuff about risk. For most, options don't score well on these three points.

There are multiple problems with the two sided option proposal described above... and you already identified one - when the stock does not move.

There are other obstacles. The first hurtle is that a reputable custodian will never allow you to make unlimited risk trades in either an IRA or Roth. This has come up often... no one has ever listed a brokerage that would allowed naked options for the average investor. More limited types of options such as buy a call or selling a covered call are more likely... but even these are not universally approved by custodians. The second hurtle, even if you could find a custodian willing to allow to do complex options, is your investment experience. I doubt anyone with less than ten years of investing experience would ever be allowed to do complex option/hedging transactions. Option trading often involves losses - and you can't write them off against other income when they are in a IRA/Roth.

Remember, using options requires a substantially higher level of knowledge. Option trading also requries substantially more time for monitoring the market, executing trades and tracking results. And, just for good measure, remember that option commissions and the implied spread (the difference between the bid/ask side of the deal) are a much higher percent of the trade than with most stocks.

#14 John G

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Posted 22 December 2005 - 10:50 PM

Nicola - I am not an accountant or tax professional, so I can't tell you what the IRS code or legal rulings are concerning you inside/outside trade proposal. (You could also make it more complicated by saying husband vs wife's trades.)

On purely practical terms, the IRS is not likely to be aware of the trades. IRA/Roth trades are not reported in the ways that brokerage account transactions are reported. Often the accounts are with different firms. For many people, they are going in and out of stock positions in a fragmented way. If you did this once, I would not worry about it. If you intend to make it a habit, you better get some guidance from a tax professional aware of your specific circumstances.

#15 ElGuapo

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Posted 23 December 2005 - 08:14 PM

Sound like wash sale, but how IRS will rule it. Any thought?

Well I for one thought it was an interesting idea. If the response so far has been a bit hostile, trader, it's only because there's some history on this board of touting "schemes," and this isn't exactly a forum for complex trading strategies. Also, I don't think your idea has anything to do with the wash sale rule (though I understand you thought it did) so this should really be a separate thread--your idea is about avoiding tax on a Roth conversion.

There are multiple problems with the two sided option proposal described above...

I'll be honest, John, I don't see how your multiple problems are relevant to trader's proposal. He's talking about two long positions, not unlimited risk. My Fidelity accounts consider these a "level 2" (out of 5) option trade, certainly allowed in retirement accounts. And yes, you have to qualify for that trading level, but it appears that trader has.

Now would the idea actually work? It certainly could on paper. But what I think trader's wondering--and what I wonder too--is would he run afoul of any PT or other rules? Something along the lines of a risk-free trade? There's also a real question, as John alluded to, about whether it would be cost-effective over time. You're basically agreeing to pay some hefty commissions with little potential for profit, all in the hopes of avoiding tax on converting the traditional IRA to Roth.

#16 John G

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Posted 25 December 2005 - 03:27 PM

ElGuapo - I thought I was clear on my negative reasons: bid/ask spread is high, commissions, extra time to evaluate/track, higher level of expertise needed, etc.. It is not correct to say that all custodians allow option trading in their IRA/Roth accounts.

In the last example that was posted, the author was only making a wager that the underlying stock price would change. He would be paying two commissions. Add the non-trivial premium cost for buying two opposing options at the same price. The trade risk rises if he buys options with a strike price gap such as using $22.50 and 25.00. In this specific example, the author is bet that the stock will change in price, but his Roth funding scheme requires the movement to favor the Roth option. What exactly is the underlying theory about this stock. None was given. This wager loses if the stock does not move sufficiently or if your timing is off. It also loses if the stock movement is insufficient to offset the transaction cost. Remember, one outcome is that the IRA side would be the winning position and the Roth "wager" would vanish.

You are talking expert level trading and there are not many option experts that read this message board. My comments are aimed at both the individual question and the overall audiance. Using the twin option strategy as a method to reduce the tax cost of a Roth conversion seems to me very far fetched. I will error on the side of caution and say - don't try this.

Option trading, because it is leveraged, can increase the volatility of your results. When you are using options, you are trying to be one step ahead of a more sophisticated investor... and the option market maker. Other than some jargon, the original question did not offer much evidence that this particular author should be using options. If anyone really wants to proceed with his idea... I suggest they try making money "on paper" for the next three months. Been there, done that, and "easy" is not the word that comes to mind.


Background article on options my Michael J. Martinez (AP) edited for space

NEW YORK - How do [brokers] make money in a sluggish, sideways market? With stocks expected to struggle for positive returns in the coming year, Wall Street will have plenty of alternatives for investors.

Many investors will likely be reluctant to commit to major stock buys or even major sales in a go-nowhere market. The competition for investors' business will remain intense.

"If you look at volume on the New York Stock Exchange and the Nasdaq over the last five years, there's been no real increase in the number of shares traded," said Richard Bove, securities industry analyst with Punk, Ziegel & Co. "In addition, proprietary trading has gone from 19 percent to 52 percent of that total. So you're seeing more competition for fewer individual trades."

As a result, retail brokers who regularly interact with individual investors are expected to try to promote more options contracts in hopes of generating more business. These contracts can let investors make a little bit of money on a stock that may not move, or cover their holdings in case of a sudden downturn.

"Options can be a very good vehicle for a variety of investors, but certainly, brokers will try to sell you on things that might not be good for your risk profile," said Randy Frederick, director of derivatives at Charles Schwab & Co. Inc. "Some options actually act as a hedge against falling prices, but investors have to be careful of more speculative trades."

Do note the implied incentives of the brokerages in the above commentary.

#17 ElGuapo

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Posted 25 December 2005 - 06:01 PM

ElGuapo - I thought I was clear on my negative reasons: bid/ask spread is high, commissions, extra time to evaluate/track, higher level of expertise needed, etc..

I'm with you there.

It is not correct to say that all custodians allow option trading in their IRA/Roth accounts.

Hope I didn't imply that.

You are talking expert level trading and there are not many option experts that read this message board.

Right, hence my comment to trader that "this isn't exactly a forum for complex trading strategies." My only point in posting was that the responses to trader's idea here ranged from confusion about terms at best to accusations about get-rich-quick schemes. Until John's latest, no one had addressed the idea itself (beyond a knee-jerk response to option trading in general), and trader's strategy is relevant to this board in its purpose of moving money from trad IRA to Roth.

In the last example that was posted, the author was only making a wager that the underlying stock price would change.

No. You're thinking of a straddle in general. He's talking about two deep-in-the-money positions. Done in a single account, this would be absolutely senseless because it's a zero-sum game (gain $1 on put = lose $1 on call). He's doing it not for profit but solely in hopes that the Roth will gain what the traditional loses. Anyway, the bottom line I think we can agree on here: this is an expensive trading strategy. Separate accounts means separate commissions and spreads, plus time value is ticking away with no real potential gains to offset it.

#18 John G

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Posted 26 December 2005 - 12:41 PM

I missed the deep in the money part... yep, that is different.

I don't think the idea is workable in any practical sense.