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More Tax Stuff

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Fiction writers are taught end chapters with a note of suspense. That prompts the reader to turn the page, the theory goes, rather than put the book down at the end of the chapter.

Last week's Trader's Corner article ended with a note of suspense, too. It ended with the suggestion that there might be ways to avoid wash-sale rule calculations altogether when computing your taxes. If you didn't read last week's article, you probably should review it before continuing. You'll find the article at this link.

One point made in that article bears repeating. I'm not a tax professional. I've made every effort a lay person might make to ensure that the information in this article is up to date and correct. However, I spend my days trading and not reading tax code or judgments in lawsuits involving tax code. The topics discussed in this article are meant only to prompt you to determine which questions you ought to be asking your tax professional and not to give advice.

One quick-fix remedy for wash-sale rule computing has been batted about for years. Here's the remedy. If you've been actively trading a security throughout the year and have experienced losses in that security, exit all trades in "substantially identical" securities some time in December and don't buy them back for 31 days. For example, imagine that you've been trading GOOG's options all year. You took a few losses in March, but mostly you reeled in big gains straight through to October. Then you took loss after loss that wiped out all your gains and then some. You have a loss for the year on your GOOG option trades.

If you keep trading GOOG options straight through the end of this year and into January, you're not going to be able to count that 2007 loss on your 2007 tax return. It's going to be folded into the basis price for the options you're buying in January. Some sites suggest that if you sell all GOOG-related securities some time in December and then don't buy back anything GOOG-related until 31 days later, the wash-sale rule no longer applies. They suggest that since you're no longer required to fold those losses into the next purchases, you don't have to make the wash-sale calculations. You just report each purchase and sale as you would normally.

You can trade in January. Just trade something other than GOOG-related securities or any others in which you've suffered losses in the last 30 days.

Logically, this sounds okay, doesn't it? Since no wash-sale losses were being carried over into the next year, the gains and losses would be identical whether all those complicated wash-sale computations were made or not. If you were to run the calculations twice--once using regular notations for each transaction and once doing all the wash-sale computations--you'd come up with the same total, because the 31-day abstention from buying "substantially identical" securities breaks the train of wash-sale computations. However, the IRS isn't always logical. We know that already, because if it was, a front-month far OTM bear call credit spread on XOM wouldn't be identical in any way to a LEAP call on the company.

As I noted in last year's article concerning tax-related considerations, I don't take anybody's word for what I should do with my returns. I'm a rule follower, and I consider myself to be an ethical person. I want to do things right all the time, and you can bet I put extra diligence into that when I'm dealing with the IRS. I called the IRS to verify that, if I refrained from trading for 31 days, beginning some time in December in that particular case, I didn't have to make the wash-sale calculations on my return. Would that be acceptable, I asked?

"I guess you could do that" and "that sounds okay" were the answers I received. Less than confidence-inspiring, aren't they? Not only is that answer less than confidence-inspiring, but also those who track the answers given on telephone inquiries to the IRS say that agents often give erroneous advice. So, we're left with "that sounds okay" and our sense that it seems ethical and logical to us. Is that enough for you? My advice is to call the IRS, ask the question, and also consult your own tax professional. The logical part of me says one thing--why make the computations--but the rule-following part of me says something else--if there's even a hint of a chance that it's a problem, maybe those computations better be made.

That's the quick-fix method for avoiding wash-sale computations, if you feel comfortable employing it or if your tax professional agrees that it's okay. A more permanent solution exists, but it has pros and cons, too. We'll discuss the solution and the pros and cons in next week's article.

If you can't wait for the information in the next article, it's essentially reprising an article written last March. You can find that article here.

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