What's wrong with "wash sales"?

Bullock · 13 June 2009

The following examples are taken from a "Cleardocs" website, (I had never heard of Cleardocs until I googled about wash sales), explaining wash sales.These examples seem to suggest that the following comments that have been made on this thread are incorrect.

"There is nothing wrong with dumping a stock and then buying it back 10 minutes later from the market"

"You can buy and sell to your hearts content during a single financial period and there's no qualms."

EXAMPLES
At the same time as Catherine sells a parcel of shares, she buys an identical parcel and claims the resulting capital loss from the sale as a tax benefit.
Most likely, benefit cancelled ”” because it appears there was no objective reason for disposing of the shares other than claiming the tax benefit.

Maria sells and buys identical parcels of shares within 24 hours and claims the resulting capital loss as a tax benefit.
Most likely, benefit cancelled ”” despite the 24 hour delay between the sale and re-purchase, it appears that the only impetus for entering into the scheme was to obtain the tax benefit.

David sold and bought equivalent parcels of shares within three days and claims the resulting capital loss as a tax benefit. Over those three days, the share price of the disposed shares improved markedly.
Most likely, benefit allowed because the scheme appears to reflect market conditions.

Who is right ?

beerwm · 13 June 2009

Sell them on June.29, and tell the ATO, you expected a large sell-off [and consequent price decline] on June.30 due to tax avoidance methods.
\

cant accuse you of a wash sale then :

jackson8 · 13 June 2009

Lone Wolf said:
So if I was to realize a capital gain by selling shares, then immediately buy back those same shares so that I was left in the exact same position as I was beforehand, there would be no requirement for me to pay capital gains? I can only assume so, I mean, fair's fair right?

hi
whats the point in buying back shares which are already in a losing position

simply put the money into something else which is going up and problem solved as then its not a wash sale

just because you have a capital loss on those you sold doesnt mean they will go up just because you have re bought them

the sp owes you nothing so put $ elsewhere

Lone Wolf · 13 June 2009

jackson8 said:
hi
whats the point in buying back shares which are already in a losing position

simply put the money into something else which is going up and problem solved as then its not a wash sale

just because you have a capital loss on those you sold doesnt mean they will go up just because you have re bought them

the sp owes you nothing so put $ elsewhere

It was purely hypothetical. I was just trying to say that if you trigger a capital gains event the ATO will tax you on it regardless of what you do next. But they won't always acknowledge a capital loss, instead they may accuse you of tax avoidance if you try to reenter the same market. But I guess that's what they do. It's their job to get money from us and to prevent people avoiding their taxes. It's not their job to ensure we aren't unfairly taxed.

Don't mind me, I've had a tax surprise this week so my opinions are a bit tainted right now.

AMSH · 13 June 2009

Whoa,

Sorry guys, please ignore my misinformed rubbish. Just went back and had a look and my understanding of this concept was way out. Lucky it never came up for a client. You're right bullock, it's the triggering of a CGT event (selling the shares) to crystalise an unrealised loss and then repurchasing the asset (or a very similar one) shortly afterwards. The period is irrelevant - intra-year trades are subject to the provision.

AMSH

MACCA350 · 13 June 2009

AMSH said:
crystalise an unrealised loss and then repurchasing the asset (or a very similar one) shortly afterwards.

So what would they class as 'a very similar asset'?

Based on that wording they could class 'similar asset' as ANY shares purchased after the sale which would mean that we could never utilise any capital loss against capital gains

For example, if I sell $10k XYZ to realise a $5k loss then purchase $10k ZYX...........I've basically purchased a similar asset, ie they're both shares and they're both the same capital amount

So what's their definition of 'similar'?

AMSH · 13 June 2009

Macca,
That's not the ATO's wording, it's mine. The ATO site is down at the mo so I can't get a look at the legislation. I'm not even sure if there are actually any provisions that relate to wash sales, from memory this type of thing comes under some blanket law that basically says if the tax office determines you've undertaken an action purely to gain a reduction in your tax liability (and there's no obvious commercial advantage to the tax payer as a result of the transaction) then it's tax avoidance and they'll treat it in line with their interpretation. If you want to disagree, you go to court and get the judge to decide who's in line and who isn't.

What I meant by "similar asset" is that if it's judged to be a wash sale by the ATO, it doesn't matter if it's actually a different asset that you've bought. I'd be very surprised if you ever got pinged for a wash sale when buying shares in different companies though.

This stuff shouldn't pose too much of a problem anyway - if you're classed as a trader for tax purposes, all trades are dealt with on the revenue account - no CGT, no wash sale. If there's a commercial interest in the way you traded and you can prove it, no wash sale. A real wash sale is going to be pretty obvious and the ATO isn't generally going to go after people for a laugh.

I'll post again when i get a look at the ATO site and I'll confirm the above.

MACCA350 · 13 June 2009

The thing is that this 'wash sale' rule is pretty silly because (without incriminating myself ) I could do what I mentioned in my previous post for the pure intention of reducing my CGT for this financial year..........and by pure intention I mean exactly that, ie I wouldn't have done it post June 30.

So really what is the point of this rule as has been mentioned already they'll get what's due in the end anyway

cheers

AMSH · 14 June 2009

It's all about the timing Macca. You're artificially bringing forward a tax effect to reduce your tax liability - there's no commercial advantage to doing so; hence it's considered tax evasion. You're right in that the net effect will be the same in the end, it's just the timing of the effect that matters.

Not sure why the ATO sees it as a big problem, maybe something to do with the time value of money, or maybe somebody's got creative with this kind of thing and they're trying to stamp it out. I suppose if people periodically realise unrealised losses (which is essentially what a wash sale is) and delay realising unrealised gains (by simply holding securities that are in profit) there could be quite a gap in CG tax revenue, in the short term at least.

AMSH

MACCA350 · 14 June 2009

How would they know a wash sale has occurred unless they audit you? The only thing on you tax return is a Capital Gains Total.........it's impossible to determine a wash sale from the tax return alone. So how do they decide who gets audited for a wash sale if they had no idea it occurred in the first place
Or do they monitor the stock market in other ways to seek out wash sale possibilities?

cheers

KurwaJegoMac · 14 June 2009

I strongly suggest everyone read over the article again, carefully, as the first half of the article has blown the issue out of proportion by the journalist in order to get a few more hits on the article.

ATO warns investors over 'wash sales'

The ATO has warned investors to be cautious about 'wash sales', the process of selling shares and buying them back a short time later to offset capital gains.

People getting their affairs in order for the end of the financial year should be cautious about disposing of shares or assets to reduce their tax, an expert says.

This is just a headline grabber to draw people's attention to the article - it scares the reader into believing the ATO is out to get them. The purpose of this section is purely to generate attention and increase the article hits/popularity.

Despite the recent signs of improvement in the global economy that have pushed local equity markets to new seven-month highs, shares remain below their levels of a year ago.

As a result, many investors are left holding unrealised capital losses, that is, shares that are trading at a lower price than when they were bought.

Some may be considering selling these shares - to crystalise any loss - before June 30 to offset capital gains from other investments.

And Garry Payne, from tax training provider Kaplan Professional, says that's a legitimate tactic to lower capital gains tax.

This section states the obvious however it presents it in such a way as to appeal to most investors. It sucks you in as most people crystalise a loss at some point or conduct wash sales - which are legitimate tactics for lowering CGT.

But Mr Payne, a tax trainer with the education company, warns investors that the Australian Tax Office (ATO) will be closely watching how the shares are disposed of, who they are sold to, and whether they are repurchased shortly after June 30.

"What the tax office is concerned about it is where you've really manufactured a sale, for example you them sell to a related party and claim the loss and then you buy them back at the same cost," Mr Payne said from Perth on Friday.

"Which means you're left in the same position exactly as you were beforehand."

Now this section is the sole crux of the entire article. I suggest you read it, then read it again, then read it once more until you understand it completely. In particular, pay attention to this line:

"What the tax office is concerned about it is where you've really manufactured a sale, for example you them sell to a related party and claim the loss and then you buy them back at the same cost"

The key word is manufactured. When you sell shares back to the market you are conducting a legitimate sale. Even if you buy the shares back immediately after, it has still been exposed to market forces and in that short time between your sell and buy order, the outlook of the stock may have changed. The ATO is concerned with those that manufacture sales - using related parties/businesses to 'purchase' the shares with the knowledge that you will be able to "..buy them back at the same cost". I.e., the related business/parties never had any intention to keep the shares, the agreement was that they would be a 'buyer' merely for the sake of allowing you to crystalise a capital loss and then they would return the shares to you and you return their money.

Think about it - if you couldn't conduct legitimate wash sales then you might not see as many day traders around - they sometimes buy and sell the same stock several times over the course of a few days in order to take advantage of price movements.

PX3T · 14 June 2009

That may well be the case KurwaJegoMac, but I can't help feeling that the ATO deliberately muddies the waters sometimes just to discourage people from claiming a legitimate tax loss where they are perfectly legally and morally able to - if they scare people into paying more tax than they have to, all the better for them and their political masters.

There has to be a line drawn somewhere as to what is legit and what isn't I suppose, but I think the article is way off mark. There are so many variations on the idea of a 'wash sale' that there is no way they could possibly determine people's intentions, that and the fact that people sometimes make illogical and rash decisions which may be read in the wrong way if an auditor is in the wrong frame of mind.

KurwaJegoMac · 14 June 2009

I completely agree with you PX3T. The whole system is structured in such a way so that it's difficult for the common person to make legitimate tax claims. For some reason a lot of people feel that it's somehow wrong/bad to make deductions and claims - maybe its too much fear from watching certain movies or something I don't know.

Trevor_S · 14 June 2009

MACCA350 said:
How would they know a wash sale has occurred unless they audit you?

How do they know anything you claimed as a deduction is not kosher unless they audit you ?

MACCA350 · 14 June 2009

KurwaJegoMac said:
"What the tax office is concerned about it is where you've really manufactured a sale, for example you them sell to a related party and claim the loss and then you buy them back at the same cost"

The key word is manufactured. When you sell shares back to the market you are conducting a legitimate sale. Even if you buy the shares back immediately after, it has still been exposed to market forces and in that short time between your sell and buy order, the outlook of the stock may have changed. The ATO is concerned with those that manufacture sales - using related parties/businesses to 'purchase' the shares with the knowledge that you will be able to "..buy them back at the same cost". I.e., the related business/parties never had any intention to keep the shares, the agreement was that they would be a 'buyer' merely for the sake of allowing you to crystalise a capital loss and then they would return the shares to you and you return their money.

Think about it - if you couldn't conduct legitimate wash sales then you might not see as many day traders around - they sometimes buy and sell the same stock several times over the course of a few days in order to take advantage of price movements.

If I'm reading this right it's not that simple. What you have pointed out is mentioned in section (i), that still leaves on market trades vulnerable to the wash sale rule:

(a)
the taxpayer disposes of, or deals with, the asset and at the same time, or within a short period after, acquires the same or substantially the same asset;

(b)
shortly prior to, or at the time of, disposing of, or dealing with, the asset the taxpayer acquires the same, or substantially the same, asset;

(c)
shortly prior to, at the time of, or shortly after disposing of or dealing with the asset the taxpayer enters into an arrangement to acquire the same, or substantially the same, asset at a future point in time at a price that is substantially the same as the sale proceeds received on disposal of the original asset and acquires that asset under the arrangement;

(d)
shortly prior to, at the time of, or shortly after disposing of, or dealing with, the asset the taxpayer enters into derivatives or financial instruments that substantially provide continued exposure to the risks and opportunities of the asset, as if the taxpayer had continued to hold the asset;

(e)
shortly prior to, at the time of, or shortly after disposing of, or dealing with, the asset the taxpayer enters into arrangements under which the taxpayer is entitled to, relative to the taxpayer's prior interest, the future income produced by the asset and/or any capital appreciation in the asset, or to a reimbursement for any future income produced by, or capital appreciation in the asset;

(f)
the taxpayer disposes of or deals with the asset to a company which the taxpayer is a member of, or to a trustee of a trust the taxpayer is a beneficiary or an object of, and the taxpayer controls or influences the company or trustee, or is the trustee or appointor;

(g)
the taxpayer disposes of or deals with the asset to a company which the taxpayer controls or has influence over but is not a member of, or to a trustee of a trust which the taxpayer controls or has influence over or is the trustee, or appointor of, but is not a beneficiary or an object of. The financial benefits of the asset are not distributed to the members or beneficiaries/objects but rather the company or trustee disposes of the asset to the taxpayer or enters into arrangements to provide the financial benefits of the asset to the taxpayer;

(h)
the taxpayer disposes of the asset or otherwise deals with the asset in circumstances where there is a significant overlap in the individuals who had direct or indirect interests in the asset before and after the disposal or dealing. For example, the asset is transferred from one wholly owned company to another, or between two trusts with the same trustee and class of beneficiaries or objects; or

(i)
the taxpayer disposes of the asset to family members and an arrangement or understanding exists between the parties to the effect that the asset will be re-acquired by the taxpayer, the future income produced by the asset and/or any capital appreciation in the asset will be provided to the taxpayer or applied for the benefit of the taxpayer, or there is otherwise no change in how the financial benefits produced by the asset are utilised by the taxpayer when compared to what occurred prior to the disposal.

AMSH, with regard to the "similar asset" we discussed, it seems there is a form of it(ie the same or substantially the same asset) in this ruling. This section clarifies their meaning:

6. An asset is substantially the same as the asset disposed of or dealt with if it is economically equivalent to, or fungible with, the original asset. An asset is also substantially the same as the original asset if there are immaterial differences between the two assets, such that in substance the assets are economically equivalent. Where a taxpayer disposes of shares in one company, and purchases shares in a competitor company that carries on a similar business, the shares in the two companies do not constitute substantially the same assets. There are material differences between the shares in two different companies, even if those companies operate in the same industry, such as scope or size of business, market performance, and returns.

So in my example earlier the ATO would not consider the share assets to be substantially the same, so no possibility of a wash sale.

Trevor, point taken

cheers

AMSH · 14 June 2009

Ok, had a look at the ato site.

First off, an on-market transaction can be considered a wash sale if the motive behind the transaction is to gain the tax advantage as opposed to some commercial interest.

See the following link and the example with "Kelly".

http://law.ato.gov.au/atolaw/view.htm?Docid=TPA/TA20087/NAT/ATO/00001

On-market sale of shares through her broker on day X. On-market purchase of shares in the same company on day X+1. Considered a wash sale. The specifics of the example make it very obvious that she performed the transaction purely for the deduction. In the real world situation, if the ato has enough belief that a transaction you're involved in is a wash sale, they'll treat it as such and the onus is on you to prove them wrong. Manufactured or not - the test is the commercial gain versus tax reduction.

So, an on market sale and buy-back can be considered a wash sale if the prime motive for doing so is judged to be the tax advantage by the ato.

KurwaJegoMac - 2 things:

Quote:

Despite the recent signs of improvement in the global economy that have pushed local equity markets to new seven-month highs, shares remain below their levels of a year ago.

As a result, many investors are left holding unrealised capital losses, that is, shares that are trading at a lower price than when they were bought.

Some may be considering selling these shares - to crystalise any loss - before June 30 to offset capital gains from other investments.

And Garry Payne, from tax training provider Kaplan Professional, says that's a legitimate tactic to lower capital gains tax.

This section states the obvious however it presents it in such a way as to appeal to most investors. It sucks you in as most people crystalise a loss at some point or conduct wash sales - which are legitimate tactics for lowering CGT.

This isn't correct. What Gary Payne is saying is a legitimate way to reduce your tax liability is to sell the shares and crystalise any capital losses prior to 30 June 200X. This is not a wash sale, but a simple sale to claim a capital loss and offset it against other capital gains. A wash sale is inherently illegitimate - that's why it's been given a name or defined at all. It occurs on the repurchase of the shares as discussed above.

Think about it - if you couldn't conduct legitimate wash sales then you might not see as many day traders around - they sometimes buy and sell the same stock several times over the course of a few days in order to take advantage of price movements.

If you're classed as a trader for tax purposes, you don't need to worry about CGT at all (with respect to your trading); all transaction are on revenue account - gains are income, losses are essentially deductions and offset against income.

That may well be the case KurwaJegoMac, but I can't help feeling that the ATO deliberately muddies the waters sometimes just to discourage people from claiming a legitimate tax loss where they are perfectly legally and morally able to - if they scare people into paying more tax than they have to, all the better for them and their political masters.

I completely agree with you PX3T. The whole system is structured in such a way so that it's difficult for the common person to make legitimate tax claims. For some reason a lot of people feel that it's somehow wrong/bad to make deductions and claims - maybe its too much fear from watching certain movies or something I don't know.

It's muddied by necessity. Guys, get a good accountant. Even if you're not trading or have a heap of investments, they are a worthy investment. it's their job to claim every single thing they can for you and often to try what's considered borderline. Tax law is incredibly complex and it has to be - accountants are always trying to poke holes in it. This is why you get a good accountant - let them deal with the ato and the complex stuff.

Cheers,

AMSH

Aussiest · 15 June 2009

Lone Wolf said:
So if I was to realize a capital gain by selling shares, then immediately buy back those same shares so that I was left in the exact same position as I was beforehand, there would be no requirement for me to pay capital gains? I can only assume so, I mean, fair's fair right?

I would have thought you had to pay capital gains tax once you realised the profit/loss? Why would you buy back in anyway? It is more beneficial to keep the shares for > 12 months if you are going to do this because you will only have to pay CGT on 50% on any gains.

Losses can be quarantined and written off against any gains you may have if you trade for investment purposes rather than for income.

PX3T · 15 June 2009

OK, so I sell a parcel of X shares in a company. What if I have already bought back X shares a week BEFORE I sell them? The net result: same. Is this considered a wash sale?

What about if I sell X/2 shares to deliberately crystallise a loss. I obtain a capital loss which can be used to offset other gains. I then buy back X shares at a slightly higher price a few days later.

Where is the line drawn? It seems to me that they want people to be happy to pay the tax on capital gains, but not always allow capital losses. Why not? I still carry the same risk, and timing is everything as they say...

Prospector · 15 June 2009

stockGURU said:
More: http://www.thebull.com.au/articles_detail.php?id=3872

What's wrong with crystalizing a capital loss before the end of the financial year to offset any capital gains and then repurchasing those same shares in July? :

That is exactly what is wrong with it, it is tax avoidance. No need to get mad, they are the rules!

Trevor_S said:
How do they know anything you claimed as a deduction is not kosher unless they audit you ?

They dont.

Krusty the Klown · 15 June 2009

AMSH said:
Macca,
if the tax office determines you've undertaken an action purely to gain a reduction in your tax liability (and there's no obvious commercial advantage to the tax payer as a result of the transaction) then it's tax avoidance

I think this is the best way to interpret if a wash sale has or is going to take place.

These provisions are not just for shares, but for any commercial asset such as property, plant and equipment, intangible assets etc. So keep in mind that a wash sale can happen between privately owned companies, individuals or companies that are owned by the same entity (intra-group transactions) - not just listed shares.

As has already been mentioned they are catch all provisions.

In terms of the net effect ie "the CGT will be paid eventually" - I think the ATO chases them now rather than later because of movements off shore. Use of tax havens, companies ceasing activity in Australia and people relocating to other countries, could see people defer the tax, move OS and then never pay it.

Like I said , catch all provisions, it just makes it messy and harder for honest people.

What's wrong with "wash sales"?

Bullock

beerwm

jackson8

Lone Wolf

AMSH

MACCA350

AMSH

MACCA350

AMSH

MACCA350

KurwaJegoMac

PX3T

KurwaJegoMac

Trevor_S

MACCA350

AMSH

Aussiest

PX3T

Prospector

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Krusty the Klown

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