Can You Defeat Long-Term Capital Gains Tax by Repeatedly Buying and Selling Stocks at a Loss?

When you sell a stock at a loss, you may think that you can offset your capital gains and reduce your overall tax bill. However, things are not as straightforward as they seem. In this article, we will explore the common practice of 'bed and breakfast' and the Wash Sale Rule, revealing the realities and limitations of this strategy.

The Bed and Breakfast Strategy

Before the implementation of strict regulations, traders in the United Kingdom and other countries commonly used the 'bed and breakfast' strategy to minimize their tax liability. This involved selling a stock at a loss and immediately buying it back the same day, realizing both a capital gain and loss, to offset against another gain. However, this strategy became less effective with the introduction of regulations such as the 30 Day Rule.

Modern Regulatory Framework

Today, the 30-day rule has made the bed and breakfast strategy much more challenging. You must wait at least 30 days before purchasing the same stock or a substantially identical one. Otherwise, the loss is considered a wash sale, and it cannot be deducted for tax purposes. Here are the steps if you want to sell a stock with a loss to offset capital gains:

Sell the stock: This action realizes the capital gains loss, but it only offset against gains if you do not buy back in 30 days. Execute a synthetic position: Another way is to simultaneously buy a long synthetic of the stock with an expiry 30/31 days from today. This can be achieved by buying a call and selling a put with the same maturity and strike. Re-enter the stock position: After 30 days, you can close the synthetic and re-establish your long stock position.

Wash Sale Rule Explained

The Wash Sale Rule is a tax regulation that disallows a loss from a sale of stock if the same stock or substantially identical stock is purchased within 30 days. Here’s how it works:

No immediate tax benefit: If you trigger the wash sale rule, you cannot use the loss to offset gains in the current tax year. Adjusted cost basis: The loss is deferred and will be recognized when you sell the repurchased stock in the future, provided you don’t trigger another wash sale at that time. Multiple transactions: Repeatedly selling and buying the same stock within the 30-day window will continue to disallow the losses until you finally sell the stock without triggering another wash sale.

Implications for Long-Term Capital Gains Tax Avoidance

If your goal is to avoid paying long-term capital gains tax by repeatedly selling and buying back stocks, this strategy is not effective if you keep triggering the wash sale rule. The Internal Revenue Service (IRS) has clear rules in place to prevent such tax avoidance strategies. Following these rules is crucial for accurate tax reporting.

Conclusion

In summary, while you can sell a stock at a loss and buy it back, doing so within the wash sale period will disallow your loss for tax purposes. This makes it a non-viable strategy for avoiding long-term capital gains tax. Always consult with a tax professional for personalized advice based on your specific financial situation.