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?
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.
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.
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)).”
This only makes sense to me if you have a very large, very diversified portfolio.
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.
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).
> 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.
> 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?
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.
There is also jurisdictions were there is no inheritance tax, which would otherwise require to sell at least some of the estate.
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.