How to Get a Double Tax Deduction When Contributing to an IRA (And Avoiding the Wash Rule)

Here's a tip I found in a recent promotional copy of Bottom Line Personal on how to get a double tax deduction when contributing to an IRA:

Sell a stock that has declined in value...and use that money [to contribute to an IRA.] You'll be able to fund your IRA and write off a capital loss at the same time!

Bonus: If the stock is one you want to hold on to, you can have the IRA buy it back. Since you and your IRA are considered separate entities, the IRS's "wash rule" will not apply.

For those of you wondering what the wash rule is, check out The Wash Sale Rule.

So, there are a couple things to comment on here:

1. Instead of taking cash and putting it into an IRA, you can sell a stock, take the loss, and then contribute, huh? Is there anything "magical" here or are they simply saying you should get as many tax breaks as you can, so if you have a stock loss, take it?

2. Interesting note about the wash sale rule -- that you are a separate entity from your IRA. Is this true? Anyone had experience with it or know the associated legal rules around the issue?

Comments

[A Tentative Personal Finance Blog]

I did that just earlier this year to max out my IRA contributions for 2006. Good tip.

[Kurt]

NOT A TAX LAWYER HERE -- UNDERSTAND THAT

The wash sale rule is comments are bogus. From the IRS (http://www.irs.gov/pub/irs-pdf/p550.pdf): If you sell stock and your spouse or a corporation you control buys substantially identical stock, you also have a wash sale.

If a completely separate person cannot buy it, there's no way you can. And here's the kicker: since you get to add any disallowed loss to the basis of the second purchase, if you do this in an IRA, not only do you not capture the loss initially, YOU LOSE IT FOREVER (since bases mean nothing inside IRAs).

Don't do this.

[Kurt]

This page seems to agree with me: http://www.fairmark.com/capgain/wash/wsira.htm

Either way, just wait until the wash sale rule doesn't apply. For small dollars (by definition, IRA contributions are) why all the headache? At worse, you lose 30 days of upside. Yeesh.

[Art Dinkin]

We recently received a trial copy of this magazine (more like a newsletter) in the mail. Out of curiosity I read it. This article and a couple others involved, in my opinion, fuzzy logic.

When you sell a security for less than you paid for it, I call that a loss... not a tax deduction. Yes, losses are deductible because they are NEGATIVE INCOME. So if you contribute $4000 to an IRA by selling a security you paid $6000 for, it seems to me that the IRA cost you $6000 regardless of the tax deductions. Assume a 25% tax rate (just to keep the math simple), a $4000 IRA "cost" you $3000 (since you saved $1000 in taxes) but a $6000 IRA "cost" you $4500 ($1500 saved in taxes). Also, like the earlier commenter, I believe wash sale rules look at control, not entities.

If the security involved still has good upside potential, just hold it. Until you sell it you have "deferred" the capital gain (which by the way is max taxed at 15% while IRA distributions are ordinary income). If the security no longer has upside potential - sell it regardless.

Smoke and mirrors my friend. Smoke and mirrors.

[Dave Evans]

I've received various Bottom Line publications over the years and found that the "advice" is short on details, often repeated, and could get you into trouble if you don't look into it further.