Tax Laws Covering Wash Sales Crystalizing a tax loss by selling is not a problem, but what you do after that could be. For example wash sales (the quick sale and repurchase of the same asset to crystalize a paper loss) is definitely not allowed. Some countries define in very clear terms what constitutes a wash sale. For example in the United States you cannot claim a capital loss if the same stock is sold and bought back within 30 days.
Australian tax laws aren’t quite as clear as that. For starters we don’t have a specific 30-day buy back rule. Instead the Commissioner asks us to interpret the less clear 80-year-old general anti-avoidance provisions in Part IVA of the Income Tax Assessment Act (ITAA )1936. You’ll run fowl of the Act if you answer yes to BOTH the following questions:
Did you obtain a tax benefit from your activity – a benefit that would not have been available if you hadn’t entered into it?
Would it be concluded that you entered into the scheme for the sole or dominant purpose of obtaining a tax benefit?
Of course people love to interpret things to suit themselves. And in the absence of specific guidelines this is exactly what they did. Which meant wash sales became very popular. But when too many people start bending the rules the antennas at the ATO go up. In 2008 it issued tax ruling TR 2008/1 which specifically outlawed arrangements where:
“in substance there is no significant change in the taxpayer’s economic exposure to, or interest in, the asset, or where that exposure or interest may be reinstated by the taxpayer”.
That’s tax Commissioner speak for – no wash sales. But a specific time frame still wasn’t defined; just don’t do it “within a short period”. Where the ruling did provide clearer definition was in banning the following arrangements:
Claiming a tax benefit from selling an asset a short time before buying it back, OR buying the same asset a short time before you sell it.
Entering into a repurchase agreement with another party (including family members). That is, an agreement to sell it now and buy it back later for a pre-determined price.
Transfers between yourself and a company or trust in which you have an interest in order to achieve the same economic benefit.
Using derivatives or financial instruments to achieve the same result.
Avoiding Penalties A breach of the Act carries penalties of up to 50% of the tax avoided. Penalties also extend to promoters of these arrangements.
In assessing your activity the Tax Commissioner will consider your intent. If it can be shown the dominant purpose of your buying and selling was to turn a paper loss into a tax-usable loss then you are in trouble. This doesn’t cover the simple act of selling and then declaring the loss.
Nor do you breach the Act if you buy and sell two different companies within a short time frame, even if they’re in a similar line of business. So selling RIO and buying BHP is OK.
Does “Ditching the Dogs” Move the Market? All this buying and selling raises an obvious question: If lots of people are dumping shares into the market in June does it influence market prices? And does it make sense to jump ahead of the queue and sell earlier to get the best price?
To answer this question let’s start with the old stock market adage: “Sell in May and Go Away””. Is it good advice? CXO Advisory Group, a bunch of US investment industry myth busters, looked at it. They studied whether superior returns could be achieved by converting from stocks to bonds in May and being out of the stock market for 6 months every year. The study, which covered a 142-year period ending in 2012, found that the strategy was beaten hands down by good old buy-and-hold. Strike one.
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