Executive Summary
The IRS has just released Revenue Ruling 2008-5, cracking down on a perceived loophole in the so-called "wash sale" rules where an individual sells a security at a loss and purchases a substantially similar security in his/her IRA. And unlike a typical wash sale where the rules simply temporarily disallow the loss, in the case of a wash sale with an IRA the loss will be permanently forfeited under the new rules!
Standard Wash Sale Rules
In the 'standard' wash sale transaction, if you sell a security at a loss, you cannot claim the loss if you purchase a substantially similar security within 30 days before or after the sale transaction. For example, if you own ABC stock that you purchased at $100 and sold for $60 (recognizing a $40 loss), you cannot repurchase ABC stock within 30 days before or after the sale; if you do, you don't get to claim your $40 loss on the sale, and instead you must add the $40 loss back to the cost basis of the new ABC purchase (allowing you to ultimately recover when the new ABC purchase is later sold). The rules apply to the sale and re-purchase of any investment security, including both stocks and bonds, and also substantially identical mutual funds or ETFs.
Beyond the straightforward rule against selling the security and having a substantially similar purchase within 30 days, the IRS and the Tax Court has also deemed that a sale by an individual and associated purchase by a spouse will run afoul of the wash sale rules, as will a sale by an individual and associated purchase by a corporation under the individual's control.
Wash Sales With An IRA - Revenue Ruling 2008-5
In its latest Revenue Ruling 2008-5, the IRS has expanded this interpretation to also state that a loss sale by an individual and an associated purchase in that individual's IRA will also be viewed as a wash sale. Furthermore, the IRS stated that the rules of IRC Section 1091(d) do not allow the individual to increase the cost basis of the IRA itself, and because the purchased security would be held inside the IRA an increase to the security's own cost basis would produce no value. Thus, and individual who runs afoul of these rules would actually permanently lose the tax loss associated with the sale.
For example, if an individual sells ABC stock for $60 with a cost basis of $100, and purchases ABC stock in his IRA within 30 days before or after the sale, the new wash sale rule of Rev. Rul. 2008-5 will apply. As a result, the individual's $40 loss will be disallowed, his cost basis in the IRA would not be increased, and any cost basis adjustment to the ABC stock INSIDE the IRA would be irrelevant. Thus, the $40 loss would be permanently lost. By contrast, if the individual had at least repurchased the security in a taxable account, the cost basis of the purchase would have been increased by $40 (the disallowed loss), at least allowing the loss to eventually be recovered indirectly via the higher cost basis when the new ABC stock was ultimately sold.
As a result of Revenue Ruling 2008-5, be very careful about purchases in an IRA when there have been sales in a taxable account of the same security! Not only does this ruling stop the overt technique of deliberately selling in a taxable account to harvest a loss and repurchasing in an IRA to maintain investment exposure, but it can also capture less intentional transactions. For instance, a taxpayer who simply wants to sell a security from his/her taxable account to hold in an IRA instead, perhaps simply for tax efficiency purposes, can unwittingly cause permanent tax damage if the security being switched happens to have a loss at the time.
Any investor will have to keep an increased scrutiny about buying or holding substantially similar positions inside and outside of an IRA if there are losses involved!
Does the rule apply if I buy the security within an employer-sponsored plan, or just an IRA/Roth?
There has never been a specific ruling on the issue in the context of an employer-sponsored retirement plan, but given the Congressional intent of the rule, I would presume it will have the same wash sale problem if you’re really buying a substantially identical security inside the plan.
– Michael
Michael, what if you but the same shares back in both an IRA and the brokerage account within 30 days? Does it matter where you bought the shares back first? In my case, I bought the shares back in an IRA 3 minutes before I bought them back in the brokerage account. Thanks for your help.
If I transfer shares from an IRA into a taxable account as part of an RMD, then two weeks later sell shares of the same stock PREVIOUSLY HELD in the taxable account, have I made a wash sale?
I have a client who sold shares to book the loss in a taxable account then accidentally bought back the shares that day in an IRA, realized what he had done, then immediately sold them in the IRA. Is there a case there to not disallow the initial tax loss in the taxable account?