Scrubbing the Wash Sale Rules

Posted: 17 May 2004

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Abstract

Loss limitations are an ugly but inevitable feature of any realization-based income tax. In essence, because the system mismeasures gains, it also has to mismeasure losses. Otherwise, the "timing option" inherent in the realization rule would allow taxpayers to defer gains (thereby reducing the tax's present value) while accelerating losses (thereby preserving the deduction's present value). The wash sale regime of Section 1091 is one of our system's most important brakes on the timing option. In broad outline, this regime defers a taxpayer's deduction when she sells a position at a loss and, within a specified period of time, acquires an economically similar position. Yet the wash sale regime is quite old, and the recent bear market has further exposed its frailty. Indeed, it is only a slight exaggeration to say that compliance with the regime is voluntary for very wealthy taxpayers - or, at least, for those who are willing to take aggressive positions.

In response, this article flags seven glitches in the regime that, at least arguably, permit "perfect end runs." This article also takes a more controversial position: Losses should still be deferred - even when taxpayers make meaningful changes in their economic position - as long as they keep material elements of their old return. This article offers two justifications for this broad loss deferral. First, under the "parity" goal, it should be difficult to accelerate losses because it is so easy, under current law, to defer gains. Put another way, since modest economic changes do not trigger gains, they should not trigger losses either. Second, under the "effectiveness" goal, the regime should be sufficiently tough that taxpayers actually give up on tax-motivated loss harvesting, instead of merely pursuing this planning in a more sophisticated way.

Suggested Citation

Schizer, David M., Scrubbing the Wash Sale Rules. Available at SSRN: https://ssrn.com/abstract=547621

David M. Schizer (Contact Author)

Columbia University - Law School ( email )

435 West 116th Street
New York, NY 10027
United States
212 854 2599 (Phone)
212 854 9740 (Fax)

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