Replacement shares with wash sale

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karlo
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Replacement shares with wash sale

Post by karlo » Mon Mar 12, 2018 10:28 am

Assume I do the following transactions:

1. Buy 1 share of XYZ for $100 and sell it for profit at $110 on January 1.

2. Buy 3 shares of XYZ at $100 and sell them for a loss at $90 on January 2.

3. Buy 1 share of XYZ for $100 and sell then for profit at $110 on January 3.

These are all my transactions for XYZ for the full year.

How many of the 3 shares I sold at a loss at $90 are a wash sale? I see that there are two buys of 1 share within 30 days of shares sold at a loss. However, the shares bought on January 1st were already sold so they cannot be considered replacement shares?

If the above reasoning is correct, then only 1 of the 3 shares sold at $90 would be a wash sale - I would claim the loss for the other two and adjust the cost basis of the share I buy in #3.

But maybe that's not the case and 2 of the shares I sold at $90 are a wash sale? And would I then adjust the cost basis of the buys in both #1 and #2? This would be quite counter-intuitive since transaction #1 is already closed.

Or maybe my intuition is completely wrong and all 3 shares sold at $90 are a wash sale?

Help would be greatly appreciated.

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House Blend
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Re: Replacement shares with wash sale

Post by House Blend » Mon Mar 12, 2018 9:14 pm

I assume you mean that each buy and sell takes place on the same day.

In that case, you don't have any wash sales. Or you do, but the net tax consequences are the same as if there were no wash sales.

On 1/2, the buy doesn't trigger a wash, since you haven't (yet) sold shares at a loss. When you sell on 1/2, then you have a loss of $30 realized, but there are no shares to pin the loss on. Still no wash.

On 1/3, when you buy, then theoretically that share is a replacement share--it acquires $10 of the loss from 1/2 (i.e., it now has a cost basis of $110). Then you sell it and the loss is reclaimed.

You end up with a net realized loss of $10 whether you or your broker reports a wash sale or not.

karlo
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Re: Replacement shares with wash sale

Post by karlo » Tue Mar 13, 2018 12:46 pm

Thank you! I understand that the net effect is the same in this case, no matter how you do the accounting. I'm only using this example to better understand the wash sale rule and how to apply it (even though it over-complicates accounting here).

In particular, I got a lot of mixed answers about whether the first buy sold for a profit on January 1 is considered a replacement share and needs to have its base cost adjusted. The most common answer I received was that 2 out of the 3 shares I sold at $90 on January 2 satisfy the wash sale definition: one because I bought less than 30 days before (in #1), and one because I bought less than 30 days after (in #3). Therefore, one would adjust the cost basis for the buys in #1 and #3 to get a 0 net gain (this absorbs $20 out of the $30 loss) and then would have a $10 net loss. However, the fact that the first buy can be viewed as a "replacement share" is very counter-intuitive to me since I already sold that position before the second buy. That's the part I don't understand. Nevertheless, I agree that the wash sale rule does not explicitly say that you need to still hold the shares from the buys that happened within 30 days at the time the wash sale executes.

To simplify the example, assume I only did the following:
1. Bought 1 share of XYZ for $100 and sold it for $110, both transactions on January 1.
2. Bought 1 share of XYZ for $110 and sold it for $100, both transactions on January 2.

Is the second transaction a wash sale which means I cannot offset by $10 loss with the previous gain? Or is it not and then I can claim the $10 loss and deduct it against the $10 profit for a $0 net gain / loss?

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iceport
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Re: Replacement shares with wash sale

Post by iceport » Tue Mar 13, 2018 12:57 pm

karlo,

Please give this article a read at Fairmark.com. The author there provides the clearest, most concise explanations I've found anywhere on the nuances of the wash sale rules. It helped me immensely; I hope it helps you as well. You'll know just about as much as anyone here after reading and understanding the nine short articles.

Wash Sales and Replacement Stock

The other 8 articles can be found on this page (scroll down to the wash sale rule section): Guide to Capital Gains and Losses
"Discipline matters more than allocation.” ─William Bernstein

livesoft
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Re: Replacement shares with wash sale

Post by livesoft » Tue Mar 13, 2018 1:04 pm

karlo wrote:
Tue Mar 13, 2018 12:46 pm

To simplify the example, assume I only did the following:
1. Bought 1 share of XYZ for $100 and sold it for $110, both transactions on January 1.
2. Bought 1 share of XYZ for $110 and sold it for $100, both transactions on January 2.

Is the second transaction a wash sale which means I cannot offset by $10 loss with the previous gain? Or is it not and then I can claim the $10 loss and deduct it against the $10 profit for a $0 net gain / loss?
No wash sales. Go try it in your taxable brokerage account and see what happens. Seeing is believing.
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rkhusky
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Re: Replacement shares with wash sale

Post by rkhusky » Tue Mar 13, 2018 1:57 pm

karlo wrote:
Tue Mar 13, 2018 12:46 pm
To simplify the example, assume I only did the following:
1. Bought 1 share of XYZ for $100 and sold it for $110, both transactions on January 1.
2. Bought 1 share of XYZ for $110 and sold it for $100, both transactions on January 2.
1. No loss -> no wash sale
2. No shares left -> no wash sale

karlo
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Re: Replacement shares with wash sale

Post by karlo » Tue Mar 13, 2018 4:06 pm

Thank you all for the help! I completely agree with you livesoft and rkhusky. If you don't have any shares left, like in my last example, it should not be a wash sale. That's the logical interpretation for me. Nevertheless, several people, including "tax professionals" on the forum of the product I use for my taxes, indicated otherwise and claimed that #2 would be a wash sale since you did a buy within 30 days in #1 and that it does not matter whether you are still holding onto those shares or not. However, that's probably not worth worrying about since the net result is the same whether you assume a wash sale or you don't.

I wish the wash sale rule would be less vague. For instance, I could not find anything in the IRS publications saying you still need to hold onto the replacement shares after the sell at a loss for that sell to qualify as a wash sale. In fact, publication 550 does not mention "replacement shares" at all - they only condition the wash sale on a buy happening within 30 days, regardless of whether or not that buy position has already been closed.

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iceport
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Re: Replacement shares with wash sale

Post by iceport » Tue Mar 13, 2018 4:36 pm

karlo wrote:
Tue Mar 13, 2018 4:06 pm
I wish the wash sale rule would be less vague. For instance, I could not find anything in the IRS publications saying you still need to hold onto the replacement shares after the sell at a loss for that sell to qualify as a wash sale. In fact, publication 550 does not mention "replacement shares" at all - they only condition the wash sale on a buy happening within 30 days, regardless of whether or not that buy position has already been closed.
Much of the official IRS interpretation of the wash sale rules is provided by past rulings and legal precedents that don't show up in the publications. That's why I find Kaye Thomas' explanations so helpful at Fairmark.com. He has stayed abreast of all pertinent IRS rulings. Where there are remaining gaps in our collective understanding of the rules, he's pretty good about disclosing the ambiguities.
"Discipline matters more than allocation.” ─William Bernstein

livesoft
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Re: Replacement shares with wash sale

Post by livesoft » Tue Mar 13, 2018 5:02 pm

I believe an ancient Pub 550 did use the term "replacement shares" ages ago. Gone now.
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libralibra
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Re: Replacement shares with wash sale

Post by libralibra » Wed Mar 14, 2018 3:43 pm

iceport wrote:
Tue Mar 13, 2018 4:36 pm
Much of the official IRS interpretation of the wash sale rules is provided by past rulings and legal precedents that don't show up in the publications. That's why I find Kaye Thomas' explanations so helpful at Fairmark.com. He has stayed abreast of all pertinent IRS rulings. Where there are remaining gaps in our collective understanding of the rules, he's pretty good about disclosing the ambiguities.
Looks like the Fairmark articles don't completely address OP's question. "5: Not So Old Shares" seems the closest, and implies OP's case would be considered a wash sale since it doesn't say explicitly that you must have held onto the old shares.

Note that this could lead to a Star Trek-like logical-infinite-loop if both #1 and #2 were sold at losses!

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iceport
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Re: Replacement shares with wash sale

Post by iceport » Thu Mar 15, 2018 12:51 pm

libralibra wrote:
Wed Mar 14, 2018 3:43 pm
iceport wrote:
Tue Mar 13, 2018 4:36 pm
Much of the official IRS interpretation of the wash sale rules is provided by past rulings and legal precedents that don't show up in the publications. That's why I find Kaye Thomas' explanations so helpful at Fairmark.com. He has stayed abreast of all pertinent IRS rulings. Where there are remaining gaps in our collective understanding of the rules, he's pretty good about disclosing the ambiguities.
Looks like the Fairmark articles don't completely address OP's question.
The second simpler example is addressed in Example 1 — selling all shares.
karlo wrote:
Tue Mar 13, 2018 12:46 pm
To simplify the example, assume I only did the following:
1. Bought 1 share of XYZ for $100 and sold it for $110, both transactions on January 1.
2. Bought 1 share of XYZ for $110 and sold it for $100, both transactions on January 2.

Is the second transaction a wash sale which means I cannot offset by $10 loss with the previous gain? Or is it not and then I can claim the $10 loss and deduct it against the $10 profit for a $0 net gain / loss?
The first pair of transactions is completely irrelevant, because no loss was realized and none can be claimed. The second pair of transactions does not create a wash sale because no replacement shares are held, as described in Example 1.

If we look at the OP, I agree, the case is not covered by any of the examples in the replacement shares article at Fairmark.com.
karlo wrote:
Mon Mar 12, 2018 10:28 am
Assume I do the following transactions:

1. Buy 1 share of XYZ for $100 and sell it for profit at $110 on January 1.

2. Buy 3 shares of XYZ at $100 and sell them for a loss at $90 on January 2.

3. Buy 1 share of XYZ for $100 and sell then for profit at $110 on January 3.

These are all my transactions for XYZ for the full year.
It seems clear to me, then, that the 1 share of XYZ bought on 1/3 should be considered a replacement share for one of the shares sold on 1/2. I don't see any reason why it should be exempt from being treated as a wash sale.

So what would happen is that loss on 1 of 3 XYZ shares sold at a loss on 1/2 would be disallowed, and the amount of the loss would be added to the cost basis for the 1 replacement share bought on 1/3. Then when that share is sold, the adjusted cost basis would be used to compute the gain or loss on that sale.
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thangngo
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Re: Replacement shares with wash sale

Post by thangngo » Thu Mar 15, 2018 1:01 pm

karlo wrote:
Mon Mar 12, 2018 10:28 am
Assume I do the following transactions:

1. Buy 1 share of XYZ for $100 and sell it for profit at $110 on January 1.

2. Buy 3 shares of XYZ at $100 and sell them for a loss at $90 on January 2.

3. Buy 1 share of XYZ for $100 and sell then for profit at $110 on January 3.

These are all my transactions for XYZ for the full year.

How many of the 3 shares I sold at a loss at $90 are a wash sale? I see that there are two buys of 1 share within 30 days of shares sold at a loss. However, the shares bought on January 1st were already sold so they cannot be considered replacement shares?

If the above reasoning is correct, then only 1 of the 3 shares sold at $90 would be a wash sale - I would claim the loss for the other two and adjust the cost basis of the share I buy in #3.

But maybe that's not the case and 2 of the shares I sold at $90 are a wash sale? And would I then adjust the cost basis of the buys in both #1 and #2? This would be quite counter-intuitive since transaction #1 is already closed.

Or maybe my intuition is completely wrong and all 3 shares sold at $90 are a wash sale?

Help would be greatly appreciated.
Hmm.. avoid those ambiguous situation where the brokerage house or the IRS might classify it as a wash sale and your whole intention is to TLH.

When you have the right setup (roster of ETF and replacement shares), the mechanic of TLH would be very simple and boring.

rkhusky
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Re: Replacement shares with wash sale

Post by rkhusky » Thu Mar 15, 2018 2:09 pm

iceport wrote:
Thu Mar 15, 2018 12:51 pm
It seems clear to me, then, that the 1 share of XYZ bought on 1/3 should be considered a replacement share for one of the shares sold on 1/2. I don't see any reason why it should be exempt from being treated as a wash sale.

So what would happen is that loss on 1 of 3 XYZ shares sold at a loss on 1/2 would be disallowed, and the amount of the loss would be added to the cost basis for the 1 replacement share bought on 1/3. Then when that share is sold, the adjusted cost basis would be used to compute the gain or loss on that sale.
And since the issue of whether there was a wash sale or not is not important until tax day of the following year, the OP problem is only of academic interest. Now, if the sale and subsequent purchase of replacement shares crossed a yearly boundary, there may be a delay of a year to realize the tax benefits of the loss. Also of interest would be if the share on Jan 3 was purchased in an IRA.

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iceport
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Re: Replacement shares with wash sale

Post by iceport » Fri Mar 16, 2018 12:19 am

rkhusky wrote:
Thu Mar 15, 2018 2:09 pm
iceport wrote:
Thu Mar 15, 2018 12:51 pm
It seems clear to me, then, that the 1 share of XYZ bought on 1/3 should be considered a replacement share for one of the shares sold on 1/2. I don't see any reason why it should be exempt from being treated as a wash sale.

So what would happen is that loss on 1 of 3 XYZ shares sold at a loss on 1/2 would be disallowed, and the amount of the loss would be added to the cost basis for the 1 replacement share bought on 1/3. Then when that share is sold, the adjusted cost basis would be used to compute the gain or loss on that sale.
And since the issue of whether there was a wash sale or not is not important until tax day of the following year, the OP problem is only of academic interest. Now, if the sale and subsequent purchase of replacement shares crossed a yearly boundary, there may be a delay of a year to realize the tax benefits of the loss. Also of interest would be if the share on Jan 3 was purchased in an IRA.
I wouldn't consider it only an academic interest. I would think the question would have bearing on the correct way to prepare the tax return documents, even if the end result doesn't change.

Then again, I sometimes wonder if the wash sale rules are slowly becoming unenforceable. It was bad enough when there were only taxpayers misinterpreting the wash sale rules. Now, since 2012, we have financial institutions routinely not reporting wash sales when they do exist, and probably reporting them when they don't, compounding the vaguery of wash sales with additional complications of faulty third party reporting.
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Doc
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Re: Replacement shares with wash sale

Post by Doc » Fri Mar 16, 2018 5:51 am

iceport wrote:
Fri Mar 16, 2018 12:19 am
Then again, I sometimes wonder if the wash sale rules are slowly becoming unenforceable. It was bad enough when there were only taxpayers misinterpreting the wash sale rules. Now, since 2012, we have financial institutions routinely not reporting wash sales when they do exist, and probably reporting them when they don't, compounding the vaguery of wash sales with additional complications of faulty third party reporting.
One of the complications of wash sale reporting that is often overlooked is the possible change in holding period of the replacement shares. That's hard enough to code. Then add different share quantities bought and sold and the possibility of chained wash sales when the same asset is bought and sold numerous times with less than 30 days between trades and the problems increase exponentially.

Try to explain to the IRS that it was your broker that said that you had both short term and long term gains for a single lot. :annoyed
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Re: Replacement shares with wash sale

Post by grabiner » Fri Mar 16, 2018 10:34 pm

Doc wrote:
Fri Mar 16, 2018 5:51 am
Try to explain to the IRS that it was your broker that said that you had both short term and long term gains for a single lot. :annoyed
I reported short-term and long-term losses on a single lot, and my broker didn't catch it (on a non-covered share; I don't know whether brokers catch this on covered shares). I purchased an ETF which distributed a long-term capital gain, then sold the ETF after less than 6 months for a capital loss. According to IRS rules, an amount equal to the long-term gain must be converted from a short-term to a long-term loss. (The purpose of this rule is to prevent you from buying a mutual fund just before it distributes a long-term gain, then selling so that you have a short-term loss equal to your long-term gain.)
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