Can buying covered calls to close trigger a wash sale

Question

I did some tax loss harvesting last week and am hoping I didn't incur a wash sale this week. Any thoughts would be greatly appreciated.

I sold a portion of CELG held long term for a significant loss in late December for $58/share. However, I had previously sold significantly out of the money covered calls at $80 on a portion of my remaining position. Since the new year, a merger was announced and those calls went in the money. As the merger value of the CELG shares is close to 100 and CELG was trading only at 83 today, I thought it made sense to stay long CELG and buy to close those covered calls for a significant loss. As I was closing the covered call position and taking a further loss, I don't see it as an issue, although now I'm wondering if one might argue that I effectively repurchased shares by doing this as I was able to stay long. However, at no time did I go long calls or actually repurchase stock.

To further complicate things, I had a preexisting CELG short 80 put position that now looks likely to expire out of the money (I had originally sold the covered calls to offset losses from the short puts). Finally, I sold a new out of the money covered call position for Jan 18 at the 90 strike today (rolled out the calls). Will the expiration of the short put (opened more than 30 days before the late December commons stock sale in question) or the sale/expiration of the short covered calls at 90 have any further implications?

Answer 1

As a retail trader, I have a lot of experience with wash sales. One thing that I can say with authority is that the IRS rules are not clear and even the tax experts have difficulty with multiple legs such as you have in your question. In the past, at times I have used a professional tax preparation program and have felt confident that if challenged by the IRS, it would be good supporting evidence. However, purchasing tax prep software is definitely overkill for one multi-legged CELG position.

What I would offer as thoughts, not fact, is that buying back your $80 covered call to close does not trigger a wash sale. Not only is it a different security but it did not change the nature of your long shares by opening it or closing it. You cannot 'effectively repurchase shares' by doing so. However, since you BTC the $80 call at a loss and then STO the $90 call, that could be construed as substantially identical. The short puts can also be construed as substantially identical if they were in-the-money when sold.

At this point, it's in the books. If any of this triggered a wash sale violation, it's in the books and can't be undone. Your tax report from your broker will break it down and if in violation, c'est la vie. If not but the IRS flags you, it's a good faith violation since you followed your broker's reporting. The worst thing that will happen is that the loss will be disallowed and carried forward to next year's tax return and you'll have to fork over some extra tax payment and possibly some interest. No bread and water diet for you in maximum security lock up.

When I have wash sale carry over violations, I reduce my first quarter estimated payment by the amount that the carry over would reduce my tax burden. So in effect, the penalty only affects me for 3 months.