IRAs give investors a lot of tax advantages. But after some taxpayers tried to push their limits, the IRS has reined them back in.
For many years, the tax community has debated whether wash-sale rules relate to IRAs, both traditional and Roth. If you're unfamiliar with wash sales, you might want to get familiar with the rules that govern them.
Once people understood that you couldn't just sell a stock and then buy it right back in the same account, the typical question went like this: "What if I sell stock at a loss in my 'regular' account and then turn around and repurchase that same stock in my IRA? Would the wash-sale rules still come into play?"
My answer -- consistently over the years -- was that wash-sale rules would still apply. You wouldn't be able to recognize the loss in your personal account, and therefore you couldn't deduct the loss on your personal tax return. But that statement created a fairly large outcry among Fools and other tax professionals. They questioned not only my intelligence but also my heritage -- and to answer them, no, I do not have a donkey anywhere in my family tree.
Both sides of the debate
Various readers would insist that since an IRA is a separate account, the wash-sale rules would not apply and the personal loss would be allowable. I continued to hold that it didn't matter whether the transactions took place in different accounts if the same taxpayer had control over both of them.
It appears that good things -- or bad things, depending on your perspective -- come to those who wait.
The IRS weighs in
Finally, the IRS has addressed this controversy. In Revenue Ruling 2008-05 (opens a PDF), the IRS essentially took the same position that I had held all along. Can you hear me patting myself on the back?
The example the IRS used in its ruling read something like this: Alex, an individual, owns 100 shares of company stock at a cost basis of $1,000. He sells those 100 shares for $600. The next day, Alex causes an IRA or Roth IRA established for the exclusive benefit of him or his beneficiaries to purchase 100 shares of the same company stock at its current fair market value. Since Alex made the transaction the next day, it came well before the 30 days before or after a sale that the IRS requires if you want to claim the loss on your taxes.
Read the entire ruling if you're at all interested in this issue. It relies on the same 1933 case that I used in my original analysis, and it will help you understand why the taxpayer has "dominion and control" in relation to the IRA.
The bottom line is that the loss Alex realized on the sale of the stock will not be allowed. It will simply be a non-transaction for tax purposes. He can't adjust the basis of any other shares that he owns in his personal account, nor is he able to adjust the basis in the shares that were purchased in his IRA. Even for wash sales, that's a particularly bad result.
If you've been playing fast and loose with this rule in the past, you might want to rethink your position. With the market on the downswing, you might be tempted to get cute with the wash-sale rules. But this recent ruling shows that the IRS is paying attention to this issue.