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When wash sale rule kicks in, then the capital loss is simply postponed by increasing cost basis to the later transaction where you again purchased similar replacement stock either 30 days before closing the first transaction or 30 days after closing the first transaction. Also, the wash sale rule can be triggered when you trade the same stock in pre-tax IRA and typical post-tax brokerage account.

So here are all the possible scenarios, where assumption is that replacement stock was bought within 30 days (Initial purchase -> Replacement purchase). How, each of these 16 cases would be taxed?

IRA->IRA

  1. Sold stock in IRA at loss, then repurchased stock in IRA and sold with loss
  2. Sold stock in IRA at loss, then repurchased stock in IRA and sold with gain
  3. Sold stock in IRA at gain, then repurchased stock in IRA and sold with loss
  4. Sold stock in IRA at gain, then repurchased stock in IRA and sold with gain

IRA->Brokerage

  1. Sold stock in IRA at loss, then repurchased stock in Brokerage and sold with loss
  2. Sold stock in IRA at loss, then repurchased stock in Brokerage and sold with gain
  3. Sold stock in IRA at gain, then repurchased stock in Brokerage and sold with loss
  4. Sold stock in IRA at gain, then repurchased stock in Brokerage and sold with gain

Brokerage->IRA

  1. Sold stock in Brokerage at loss, then repurchased stock in IRA and sold with loss
  2. Sold stock in Brokerage at loss, then repurchased stock in IRA and sold with gain
  3. Sold stock in Brokerage at gain, then repurchased stock in IRA and sold with loss
  4. Sold stock in Brokerage at gain, then repurchased stock in IRA and sold with gain

Brokerage->Brokerage

  1. Sold stock in Brokerage at loss, then repurchased stock in Brokerage and sold with loss
  2. Sold stock in Brokerage at loss, then repurchased stock in Brokerage and sold with gain
  3. Sold stock in Brokerage at gain, then repurchased stock in Brokerage and sold with loss
  4. Sold stock in Brokerage at gain, then repurchased stock in Brokerage and sold with gain

Here is my understanding which may be wrong:

  • in cases 1,2,3,4 wash sale rule should not matter at all because both transactions were made in pre-tax IRA account anyway. Right?
  • in cases 4,8,12,16 wash sale rule should not matter because both transactions were with with gain. Right?

However, I am confused about:

  • cases 5,6 because can I really use loss from my IRA account to increase cost basis for transactions made in my Brokerage account? If so, then this sounds like a nice tax loophole where pre-tax loss could be used to offset post-tax gain.
  • cases 9,10, because do I really have to pointlessly increase cost basis for IRA transaction and give up my rights to keep capital loss in my brokerage accou t? If so, then this sounds like a "tax trap" that should be avoided at all costs.
  • in cases 3,7,11,15 wash sale rule does not matter, because first transaction was with gain and the second transaction will remain as-is without requiring cost basis recalculation. Right?
  • in cases 13,14 any capital loss really would not be lost, but simply postponed to the second transaction. Typically this should not matter unless you were planning to claim loss in particular Tax year when first transaction was closed, but could not because capital loss was moved to next Tax year.
  • Your statement is wrong from the beginning. The sale that's "wash" can occur before the buy. The rule is based on 30 days before or after. Do you want that included in your question? If so, how? – user32479 Mar 26 '16 at 23:36
  • @Brick Thanks for the sharp eyes. Did I update the question correctly to reflect that 'first transaction can get classified as "wash sale" also, if second transaction was opened 30 days before closing the first transaction'? Though, I don't think it would matter much for those 16 cases. – john1234 Mar 27 '16 at 0:09
  • OK, so one more point - The issues raised in your question apply to both traditional and Roth IRA. You've emphasized "pre-tax IRA" but any IRA comes into play. – user32479 Mar 27 '16 at 2:05
  • 1
    You've turned a relatively straightforward process into something that appears to have far more outcomes than those that matter. Sell at a gain? No potential wash. Buy and sell, all in retirement accounts, no wash. I think this leaves 4 or fewer scenarios out of your 16. The only scenarios that matter are 9,10,13,14. 9 and 10, the loss is gone. You don't adjust basis inside the retirement account. 13/14 is the wash sale discussed in multiple other questions . – JTP - Apologise to Monica Mar 27 '16 at 19:50
5
+100

The wash sale rule only applies when the sale in question is at a loss. So the rule does not apply at all to your cases 3, 4, 7, 8, 11, 12, 15, and 16, which all start with a gain. You get a capital gain at the first sale and then a separately computed gain / loss at the second sale, depending on the case, BUT any gain or loss in the IRA is not a taxable event due to the usual tax-advantaged rules for the IRA.

The wash sale does not apply to "first" sales in your IRA because there is no taxable gain or loss in that case. That means that you wouldn't be seeking a deduction anyway, and there is nothing to get rolled into the repurchase. This means that the rule does not apply to 1-8. For 5-8, where the second sale is in your brokerage account, you have a "usual" capital gain / loss as if the sale in the IRA didn't happen. (For 1-4, again, the second sale is in the IRA, so that sale is not taxable.)

What's left are 9-10 (Brokerage -> IRA) and 13-14 (Brokerage -> Brokerage).

The easier two are 13-14. In this case, you cannot take a capital loss deduction for the first sale at a loss. The loss gets added to the basis of the repurchase instead. When you ultimately close the position with the second sale, then you compute your gain or loss based on the modified basis. Note that this means you need to be careful about what you mean by "gain" or "loss" at the second sale, because you need to be careful about when you account for the basis adjustment due to the wash sale.

Example 1: All buys and sells are in your brokerage account. You buy initially at $10 and sell at $8, creating a $2 loss. But you buy again within the wash sale window at $9 and sell that at $12. You get no deduction after the first sale because it's wash. You have a $1 capital gain at the second sale because your basis is $11 = $9 + $2 due to the $2 basis adjustment from wash sale.

Example 2: Same as Example 1, except that final sale is at $8 instead of at $12. In this case you appear to have taken a $2 loss on the first buy-sell and another $1 loss on the second buy-sell. For taxes however, you cannot claim the loss at the first sale due to the wash. At the second sale, your basis is still $11 (as in Example 1), so your overall capital loss is the $3 dollars that you might expect, computed as the $8 final sale price minus the $11 (wash-adjusted) basis.

Now for 9-10 (Brokerage->IRA), things are a little more complicated. In the IRA, you don't worry about the basis of individual stocks that you hold because of the way that tax advantages of those accounts work. You do need to worry about the basis of the IRA account as a whole, however, in some cases. The most common case would be if you have non-deductable contributions to your traditional IRA. When you eventually withdraw, you don't pay tax on any distributions that are attributable to those nondeductible contributions (because you already paid tax on that part). There are other cases where basis of your account matters, but that's a whole question in itself - It's enough for now to understand 1. Basis in your IRA as a whole is a well-defined concept with tax implications, and 2. Basis in individual holdings within your account don't matter.

So with the brokerage-IRA wash sale, there are two questions: 1. Can you take the capital loss on the brokerage side? 2. If no because of the wash sale, does this increase the basis of your IRA account (as a whole)? The answer to both is "no," although the reason is not obvious. The IRS actually put out a Special Bulletin to answer the question specifically because it was unclear in the law.

Bottom line for 9-10 is that you apparently are losing your tax deduction completely in that case. In addition, if you were counting on an increase in the basis of your IRA to avoid early distribution penalties, you don't get that either, which will result in yet more tax if you actually take the early distribution.

In addition to the Special Bulletin noted above, Publication 550, which talks about wash sale rules for individuals, may also help some.

2

Brokerage->Brokerage 13-16

  1. The loss from the previous purchase will be added to the cost basis of the security for the second purchase. Since you sold it at a loss again it would increase your losses. Your loss from the first sale will be disallowed.

  2. Your loss will be added to the cost basis of the next purchase. Your gains will be taxed on the total of the cost basis which will reduce your gains. Which you will taxed 'less'.

  3. Your gains will be taxed. Your loss is allowed.

  4. You will be taxed on both.

Wash Sales really only applies to losses. If you sell for gain, the tax man will be happy to take his share.

From my understanding, it does not matter if it is IRA or Brokerage, the wash sale rule affects them all.

Check this link: http://www.marketwatch.com/story/understanding-the-wash-sale-rules-2015-03-02

  • Perhaps just terminology, but in case 13 with "your loss from the first sale will be disallowed" did you really mean that if I have $1000 loss and then again $1000 loss, then I can't add the first loss to the cost basis of the second transaction and have $2000 total loss? – john1234 Mar 25 '16 at 19:25
  • I gave you +1, but I will accept the answer if cases 1-12 can be explained as well. The link you sent does not seem to go into IRA details. – john1234 Mar 25 '16 at 19:39
  • @HalfWay your right the link does not go into detail about IRA but does state that it does not matter if your on a joint brokerage account or IRA, the wash sale applies. – NuWin Mar 25 '16 at 19:40
  • @HalfWay For case 13, what I meant by disallowed is, you can't use those losses for tax reductions. Your original loss will be added to the cost basis on the purchase of the second loss. – NuWin Mar 25 '16 at 19:44
  • The rule for IRAs is more complicated than this answer implies. The info at the link only touches on that complication. – user32479 Mar 26 '16 at 23:44

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