Wash Sales: IRAs and Other Related "Persons"

Tax planning that's too good to be true

By Kaye A. Thomas
Updated May 30, 2007

Tax risk if you buy stock in an IRA after selling the same stock at a loss.

It's downright amazing how often we get this question:

If I sell stock at a loss, is it OK to buy it again right away in my IRA?

The concern, of course, is the wash sale rule. If you buy the same stock right away in a regular brokerage account, the wash sale rule says you can't deduct the loss on your sale. It's natural to wonder if you can avoid this rule by buying the stock in an IRA. If it worked, this approach would allow you to have your cake and eat it too: you would get to deduct your loss while continuing your investment in that particular stock without interruption.

There's plenty of confusion about this rule, even among tax professionals. The answer, according to an IRS publication, is that you lose the deduction if you buy replacement shares in your IRA. The problem is that the answer isn't easy to find.

Wash Sales and Related Parties

If Congress were writing the wash sale rule today, they would make it apply to related parties. They did that for more recent rules dealing with financial transactions, such as the constructive sale rule. Yet the wash sale rule is relatively ancient and has never been brought up to date. Nothing in the law says it applies to related parties.

If that were the end of the story, you could go ahead and buy replacement stock in an IRA. You could also have your spouse or another relative buy replacement stock, or use an entity you control (such as a corporation, a trust or a family partnership) to buy replacement stock. No one would have to worry about the wash sale rule because it would be so easily avoided. That sounds too good to be true, and it is. But why?

Sales to Related Parties

The wash sale rule is only one of the rules that can prevent you from claiming a deduction when you sell stock at a loss. You lose the deduction also if you sell to a related person. In the special language of the tax law, a "person" includes not only human beings, but also entities like the ones mentioned above: corporations, trusts, partnerships — anything that can be used to maintain indirect ownership of other assets, including stock.

If you sell stock at a loss to a related person, you can't deduct the loss. What's worse, unlike a wash sale, a sale to a related person prevents you or the related person from claiming a loss deduction on a later sale. That's a painful result, but you may be wondering what it has to do with the original question. No one ever said anything about selling stock to an IRA. The idea is to use the stock exchange to sell the stock to a stranger, and then, in the IRA, buy replacement shares, presumably from a different stranger.

Indirect Sales

The IRS says a contemporaneous sale and purchase should be treated as an indirect sale to a related person if they occurred together as part of a plan. Their position is backed up by decisions where courts ruled in favor of the IRS. Here's a quote from IRS Publication 550:

Indirect transactions. You cannot deduct your loss on the sale of stock through your broker if, under a prearranged plan, a related party buys the same stock you had owned. This does not apply to a trade between related parties through an exchange that is purely coincidental and is not prearranged.

The IRS allows for the possibility that a purchase of replacement shares could occur by coincidence, for example if you and your adult child are both active investors who trade independently. Realistically, no one is going to believe the transactions were coincidental if the same person directed both of them. And that's exactly what's going on when you sell stock in a brokerage account and buy replacement shares in an IRA.

The IRS position is backed up by a ruling by the Supreme Court in a 1947 case called McWilliams (331 US 694). That case deals with a situation where a husband sold stock at a loss and had his broker buy replacement shares for his wife's account. I can't think of a good reason to treat repurchase in an IRA any differently.

Caveat Lector

It's possible you'll find a contrary opinion, perhaps even from a reputable tax professional. The main reason for this is that you can study the wash sale rule all you want without finding anything about related parties. Most people won't even think of the rule for sales to related parties, because you aren't actually selling to your IRA.

Another reason for confusion is that the tax law uses rather arcane language to tell us when a trust is a "related person." It's easy to get hung up in that language and convince yourself that an IRA isn't related to its owner. Common sense tells you otherwise, and so does the tax law if you can work through the technicalities.

According to one article I saw, an IRS agent posted an answer to this question on the IRS web site saying it was OK to buy replacement shares in an IRA. Every year the IRS gives many thousands of incorrect answers in informal guidance of this kind. The official position of the IRS is the one quoted earlier from Publication 550, not the offhand response of an agent responding to an email question.

Reality Check

The wash sale rule and the rule for sales to related parties work together for a single purpose: to prevent you from claiming a loss deduction while maintaining uninterrupted ownership of your stock. If you aren't willing to part with the stock, you aren't eligible for the deduction. Buying replacement shares in an IRA is a gimmick designed to defeat the basic purpose of these provisions. It shouldn't work, and if the IRS position in Publication 550 is upheld, it won't.