Hacker News Reader

Comment by dataflow | Hacker News Reader

I don't really understand how this works. So you buy stocks A and B in identical amounts, and A increases by the same amount that B drops. You need cash, so you sell A, but you don't want to pay taxes on the gains on A, so you trade B to offset the losses. But that lowers B's cost basis, so the next time it rises, you'll have more of a tax liability than you did earlier, right? Whereas if you didn't trade B, you'd have avoided that difference. I feel like I'm not thinking it through sufficiently - how does repeating this process end up being a net benefit for you?

Update/summary for those reading: The answer seems to be (if I understand the comments below correctly) that inherited assets' cost bases magically get stepped up to their fair market value without tax consequences, which would explain why kicking the can down the road is beneficial, as well as one reason why generational wealth is such an incredibly impactful loophole.

View on HN

You are right that it defers, but does not eliminate, taxes; however:

1. You can use losses to offset $3k of ordinary income per year.

2. Tax deferral is still advantageous. For example, you can defer until retirement when your tax bracket is lower, and also allow that amount to compound in the meantime.

3. If you die, your heirs get a step up in basis, so the tax is in fact ultimately avoided.

For a billionaire, (1) and (2) seem basically irrelevant; if they're loopholes at all, they seem to favor the non-billionaires. That leaves us with (3), which baffles me - if the cost basis is allowed to rise without paying any taxes (?!) then isn't that the real source of the problem, rather than the wash sale? I feel like I must be missing something here - why get angry over wash sales and prohibit them if the real issue is something else entirely? Shouldn't inheritance basis step-up be the real subject of discussion?

I agree with all of that. Hand wringing over tax loss harvesting seems silly to me.

I think there are very good historical reasons for basis step-up, namely, that it is unreasonably hard to expect heirs to figure out basis from a deceased, especially for illiquid assets. But since brokerages have to track basis since 2012, it would seem easy to, at least, disallow basis step-up for securities that have cost basis information held by the brokerage.

> namely, that it is unreasonably hard to expect heirs to figure out basis from a deceased, especially for illiquid assets

But then can't they assume the cost basis is $0 if they can't provide documentation to back up something higher? I thought that's how it works in general when you don't have cost basis information available.

Sure, but that's probably going to unfairly impact the poor. Imagine a family of poor immigrants, where the father worked very hard and saved and left some asset to his non-rich children...you want to punish the children when the father dies suddenly and the children have no idea where to find cost basis information? There are pros and cons to any policy.

you can also limit step up cost basis, similar to how the "estate tax" is limited (and is high enough that even "normal" rich people aren't event impacted by it. But I'd limit the step up stricter than that. imagine the step up would be limited to 1-2mil of stepped up assets. poor people would still be able to benefit, nominally middle class/well to do upper middle class would also mostly benefit, but the rich would find the benefit effectively go to zero for them as their assets rise.

> Hand wringing over tax loss harvesting seems silly to me.

It seems very pertinent to me. Taxes pay for the common good.

If people are using loopholes or workarounds to not pay tax, then the common good suffers.

And we all benefit from the common good, even, maybe perhaps _especially_ the billionaires whose companies receive subsidies, or contracts from the government.

Seems like being tax efficient to me.

People realize the 401k was once a “loophole”? Some CPA found the law and started to use it and everyone piled on.

I as a average 1-job salary earner really enjoy the tax loopholes of my IRA and 401k.

A portion of taxes goes to the common good, another portion goes to graft and politicians per projects that accomplish nothing; sometimes both at the same time. Maybe we fix that first.

I've argued that heirs, if they don't have proof of the basis, should have to treat the basis as 0.

Why should the basis be what it is today vs zero? It's pretty simple, if person dies on day N, and we know what we would tax the item as if he sold it on day N-1, then we should be able to know what we should be able to tax it at if sold by the heirs on day N+1.

Zero would acknowledge that the heirs paid literally zero for it. conversely, if the the asset tremendously rose in value (i.e. an order of magnitude or more). then even with knowing the cost basis, one can effectively treat the cost basis as zero without significant effect on the heir (i.e. at a 33% tax rate, if it grows by an order of magnitude and you treat it as 0, instead of 10% of the current value, you only increased the amount of tax paid by 3.3% of the value). If it grows by even more than an order of magnitude, than the percentage drops (2 orders of magnitude and you are at 1/3 of a percent extra vs treating it as zero).

i.e. there really isn't much of a loss to the heir if one has to treat the asset as zero cost basis. and one can always provide said cost basis in the cases where the asset growth can't be measured in even a single digit order of magnitude (but once one breaks a single digit, then there's very little loss to the heir).

In general, I dislike trying to treat different assets classes differently, the rule should be no step up, track cost basis or you as the heir have to treat it as zero.

Number 2 is definitely not irrelevant for billionaires, perhaps especially for billionaires. Deferring taxes means that your investments can achieve faster compound growth.

See the "Financial Impact of Tax Deferral" section in this article, https://www.securitybenefit.com/tax-center/article/how-tax-d....

Compounding isn't a magic potion that gets you infinitely wealthy though. The highest tax bracket is at < $400k. Over retirement that's a total difference of... say, $10M? We're worried about $10M for someone who has $85B in assets? How much of the $85B do you believe consists of compounding from that $10M?

I literally have no idea what you mean by your numbers. "The highest tax bracket is at < $400k. Over retirement that's a total difference of... say, $10M?" I don't understand this at all.

If you're trying to take advantage of a lower retirement income bracket post-retirement, that's only valuable for < $400k of income/year. Anything after that will be at the highest bracket. Over the course of your post-retirement life that seems to come out to something on the order of $10M in tax savings. Which wouldn't really amount to much for someone with $85B in assets.

It's not only about being in a lower tax bracket in retirement. Tax deferral means that your compounding rate of return will be faster now before you retire, because instead of giving money to the government you can invest it in something that produces a return. I think the section of the article I linked explains it pretty well.

I get that. But how much do you think $10M right now would compound to? How would that compare against an >$80B net worth?

The article does not explain anything. There's no math to back it up either. From what I understand, the difference in the compounding rate of return is actually 0 at all time if you add the liquidation tax liability (which you have to) as a negative value to the net worth graph. The only benefit is that tax brackets (might) go down, which is exactly what people are saying.

More than that: we are talking about stock sales. Long term sales are not part of tax brackets. 18% flat right now, until the law changes. And it can only increase, since we are now in a middle of mad deficit spending. So deferring taxes has it’s own risks.

> 18% flat right now

No, it is not. It adds 5% when you cross into the top tax bracket.

> if the cost basis is allowed to rise without paying any taxes (?!)

It's a common misconception that the step-up in basis means the heirs don't pay taxes, and therefore the billionaires are giving us the biggest shaft.

The heirs pay estate tax, and once they pay the tax, the basis resets. It would be very unfair if it didn't. However, the tax exemption for the estate tax is quite large (about $13MM for federal for 2023, but going to $7MM in 2026).

For billionaires though, the estate tax exemption is negligible. The heirs end up paying estate tax for everything they inherit minus $13MM, which is nothing for them.

So, again, if this benefits anyone, it's the less rich people.

Thanks, that makes a lot more sense now. Then we go back to my initial question - where exactly is the loophole here? The tax is being deferred, not avoided entirely. Yet the article makes it seem like they somehow avoid it?

They do not want to tell you: we want to close this tax planning possibility that everyone - including you - can use. So they tell you: Steve Balmer, loophole, avoidance!

The original “wash sale” prohibition is pretty unfair and damaging to every single stock owner. Since it does not hold water mathematically, it’s prone to loopholes. You need to spend more time to find loopholes - so only wealthy tend to benefit from them. You want to make stock ownership more “equitable” - repel the original “wash sales” law.

Re 2 - we are talking about stocks, they are taxed independently of your tax bracket. Tax % on stocks changes only when law changes, and this can only rise, given our current situation.

Overall, the article is against tax planning, picturing it (deliberately? due to math incompetence?) as tax avoidance. You do not need to be Steve Balmer to wish to use some tax planning, ask me how I know - and I am just a software engineer.

It's more like this: stock A offers exposure to X (say resource extraction, pharma, tech, small cap growth.. whatever). Stock A also went down in value this tax year but you're still confident in your investment thesis, so you find stock B, which also has similar exposure, this could be a different ETF, a different company or even a different class of shares in the same company (sell GOOG buy GOOGL). You sell A to create a loss on paper and purchase B with your proceeds. This allows you to create paper losses to offset your tax liability from any sales that produced capital gains while keeping, roughly, the same allocation without violating the wash sale rule.

I guess perhaps what I'm not quite understanding is why wash sales are disallowed in the first place - because, again, if you lower the cost basis, you will be liable for the difference in the future, so why does it make a net difference?

Because they never realize capital gains. Instead they take a loan and use the stock as collateral to get liquidity . They never pay back that loan, but just pay interest, which again lowers their taxable income.

They do pay capital gains, even if a loan differs it. If the individual dies before repaying the loan, their estate pays a tax rate much higher than capital gains as it cashes out assets to settle its debts.

I'm not sure how, but the "margin debt is an infinite free money hack" somehow caught on and won't go away. It's not a free money hack, it's debt that must be repaid with income. Which is always taxable.

I'm not sure how it works in the US , but there are plenty other jurisdictions were the estate is not required to settle debt but may just transfer it to the heir.

There is also jurisdictions were there is no inheritance tax, which would otherwise require to sell at least some of the estate.

Nope.. It IS a free money hack for the wealthy. The stepped up basis happens the day of your death. So when the estate sells assets to cover the liabilities, the profit of the sale will be calculated by subtracting the new stepped up basis from the sale price (effectively $0) so no tax.

Additionally, the wealthy will usually leave only enough assets in the estate to cover the liabilities plus maybe some more up to the estate tax threshold so it goes through tax free to the heirs. The rest will have been distributed through various other methods to avoid taxation.

Do I understand correctly that you're basically saying low inheritance taxes are (most of) the justification for wash sale rules?

No, I don't think inheritance tax factors in here that much. Wash sale rules don't really apply when using the step up basis loophole.

The intent of disallowing wash sales is to stop people from gaming the system to strategically realize "fake" losses in one security to offset gains. If we allowed wash sales you could make 100 dollars in profit from your sale of stock A and then wash sale 10 shares of stock B at 10 dollars, down from 20 and say you made no money this year, when, effectively you made 100 dollars and you still have the same number of shares of stock B.

The intent of performing the wash sale isn't to reduce your liability from proceeds of the future sale of whatever security you're trying to "wash", it's to use the wash to offset this year's gains from the sale of other securities.

You're not accounting for the reduction in cost basis that would increase your future taxes though?

Like some other commenters have called out it kind of just kicks the can down the road, but the longer you can kick that can down the road the longer you can reap the benefits of compound interest.

I get that part but the difference in compound interest still seems too small compared to their multi-billion-dollar assets. The real issue seems to be inheritance tax cost basis step-up, if I'm understanding correctly. Which would explain why generational wealth is such a bigger deal than people give it credit for.

Yes, you and I would have reaped the benefits of compound interest - if the “wash sales” law is repealed. What’s wrong with that?

A couple of things wrong with wash sales:

1) I can't reap the benefit, because I don't have enough income to save for retirement (outside of my pension). If I did, like most people, I'd likely be saving in something like a 401(k) that is tax-deferred. Tax-deferred retirement accounts, by law, gain no additional tax benefit from a wash trade. https://www.irs.gov/newsroom/what-if-my-401k-drops-in-value

2) You incentivize people to sell and buy additional securities outside of their normal investment planning. This will have a market distorting effect when compounded over many, many stockholders.

I think they defer as much as they can until they die and their heirs get to inherit with a stepped up cost basis and they never pay tax. Borrow, buy, die.

If they’re really crafty, the heirs will overvalue assets when stepping up the cost basis so they can actually claim losses in the future.

From Wikipedia:

“The tax code of the United States holds that when a person (the beneficiary) receives an asset from a giver (the benefactor) after the benefactor dies, the asset receives a stepped-up basis, which is its market value at the time the benefactor dies (Internal Revenue Code § 1014(a)).”

Let's not forget how the US just conveniently doesn't go after the wealthy for tax fraud, because it's too difficult given they can hire armies of CPAs and lawyers to defend themselves.

The US does go after the wealth for tax fraud. I think the bigger issue is that the wealth pre-emptively hire CPAs/lawyers to take maximum advantage of tax rules in a way that may not be prohibited, innovating faster than legislators can act.

IRS Audits Few Millionaires But Targeted Many Low-Income Families in FY 2022: https://trac.syr.edu/reports/706/

The IRS may be underfunded, but it's misleading to say the IRS does not go after the wealthy for tax fraud. The chart in that article shows $1M+ earners to have the highest audit rate, albeit some of it correspondence audit, and says 25% of audit man hours are spent on millionaires.

I'm neither an accountant nor a billionaire, but it seems like wealthy people will always have a certain amount of stock that is in a loss position. So if the "washed" stock appreciates and they want to sell it, there will be other stocks in a losing position that can wash the washer. You can therefore defer those taxes indefinitely.

This only makes sense to me if you have a very large, very diversified portfolio.

> there will be other stocks in a losing position that can wash the washer.

That is equivalent to “your stock portfolio will never grow”.

> This only makes sense to me if you have a very large, very diversified portfolio.

You do not need to own much of the stocks to observe a fall relative to the purchase price in a stock you want to keep. The original “wash sale” prohibition just complicates tax planning - for everyone. Since it’s mathematically absurd, it’s prone to loopholes. But you need to spend time to find the loopholes, so wealthy people are (and will) suffer less.

“Wash sale” prohibition harms ordinary stock owners, like me, much more than it harms Steve Balmer.

> That is equivalent to “your stock portfolio will never grow”.

Realized gains are the only gains that are taxed. You aren't paying capital gains taxes on stocks when you aren't cashing them out.

So if a person has $100 million in stocks, some of which are up, and some of which are down. Decides to take out $1 million for a birthday party. And then wash trades a million dollar "paper loss" in their portfolio to cover for the $1 million they cashed out.

They'll still have practically the same portfolio, some of which has gained, and some of which has lost, minus the shares they sold to pay for the birthday party. If they invested well, it's possible that their overall portfolio has indeed gained. But thanks to the wash trade they don't have to pay any taxes on the $1 million in gains that they just cashed out.

> “Wash sale” prohibition harms ordinary stock owners, like me, much more than it harms Steve Balmer.

If you own it in a 401(k) or equivalent you can't claim capital gains losses as a deduction regardless (not until you start taking it out following retirement).

I own both 401k, which is mostly in mutual funds (and which are hurt every time you try to hurt Steve Balmers of this world) and also I manage some after-tax portfolio on my own (the experience I warmly recommend to anyone who is trying to understand the effects of proposed tax changes on ordinary investors).

> And then wash trades a million dollar "paper loss" in their portfolio to cover for the $1 million they cashed out.

This scenario that bothers you is pretty much unrealistic. It’s mathematically impossible if your portfolio grows to offset each cash out with a paper loss. Especially with securities you want to hold. Usually you just sell, register an offsetting loss and forget about the losing stock.

And in your calculations you forget the price I paid into the positions. So a year ago I had $200 and put them into stocks A and B, $100 each. Today I’ve sold A for $150, B for $50, got back $200 with zero profit per year. Zero profit - zero taxes, fair?

Now I’ve decided that $200 is a bit more than I need and decided to put $50 back in the market. What to buy? Oh, B looks good at $50, let’s put $50 back there. Suddenly, the tax collector says “this purchase (spending money on the stock) turns your $0 profit into $50 profit, taxes please”. How comes?

Note that my purchase of B back is not free. I will owe taxes if I sell it for more than $50 (previously - only if I sell it for more than $100). Also, for a year any profit on B will be taxed as an ordinary income, which can be much more than 18% on a long term sale.

TLDR. “Wash sale” rule creates more harm than good for an individual investor, and any harm it inflicts on Steve Balmers of the world is inflicted on 401k’s of the working people.

How does discouraging wash trades hurt mutual funds? Selling a losing position seems like it would put downward pressure on that particular stock price. Turning around and buying an equivalent position seems like it would put upward pressure on that particular stock price. The only benefit to mutual funds seems to be that if you tax any money the Ballmer's of the world cash out, then you reduce the amount they can put in. Putting in more money would help the current mutual fund price, sure, but it would also make it more expensive compared to the underlying assets for future purchases of that fund.

> It’s mathematically impossible if your portfolio grows to offset each cash out with a paper loss

Unless you have a very, very large and distributed portfolio compared to the amount of cash you are taking out any given year. Such as for a billionaire who wants to bequeath their billions to a tax-free charitable trust after they die.

> And in your calculations you forget the price I paid into the positions.

I was making the math easy for rhetorical purposes.

> Suddenly, the tax collector says “this purchase (spending money on the stock) turns your $0 profit into $50 profit, taxes please”. How comes?

Because you haven't "realized" the loss in B. Instead you've made a market-manipulating double trade.

If I make a loss tomorrow I still have to pay my income taxes. Why should it be different for stock market purchases?

It's not that.

Let's take a concrete example given in the article. BHP group. You can buy BHP shares in 3 different primary listings. BHP.L[1] (on the LSE, listed in GBp), BHP[2] (on the NYSE, listed in USD) or BHP.AX[3] (listed in AUD on the ASX). These are fundamentally the exact same shares in the same company, but are listed in different countries. The only difference between them is the listing currency you pay to buy/receive on sale. When you receive the shares you actually get the same exact ISIN (I believe).

So say you hold some BHP and its price is underwater at the moment. You believe in the long-term prospects of the company and have made profits in general that you have to pay tax on. You could sell the BHP, realise the loss (offsetting these other taxes to an extent) and buy again. However that "bed and breakfasting" (as it used to be called in the UK) has been declared illegal. If you were to sell in the US and then immediately buy on any US market that would be illegal. But if you sell in the US and then buy in London or Sydney (in this example) that is allowed.

How the tax advantage works is you are literally taking an extra mark-to-market loss and offsetting that against other profits. Yes if you instead held and eventually made a profit you would pay less in that scenario, but in that scenario you are paying in future dollars whereas with the offsetting you are gaining today's dollars. Today's dollars are more value because of discounting.

[1] https://finance.yahoo.com/quote/BHP.L?p=BHP.L&.tsrc=fin-srch

[2] https://finance.yahoo.com/quote/BHP?p=BHP&.tsrc=fin-srch

[3] https://finance.yahoo.com/quote/BHP.AX?p=BHP.AX&.tsrc=fin-sr...

If you read the article it is straightforward. Companies have two securities that are "legally distinct" and you sell one for the tax loss and buy the other to keep your position.

My question was not about the tactic but about the strategy.

Reply on news.ycombinator.com