Calculating Adjusted Holding Period
February 8, 2010 6 Comments
Related statutes and regulations are currently ambiguous with regard to determining adjusted holding period under the wash sale rules. The issue is whether short or long term capital gains treatment upon disposal of wash sale adjusted shares is determined (a) by computing actual days held for the original shares plus any and all instances of replacement shares (referred to as the ‘holding period’ approach), or (b) using the acquisition date of the originally disallowed loss as the adjusted acquisition date for any and all instances of replacement shares (referred to as the ‘holding date’ approach).
Silver believes the holding period approach to be highly problematic and open to abuse, while the holding date approach is far simpler, more consistent with the intent of the wash sales rules, and cannot be similarly abused.
It is important to realize that under wash sale rules, losses may be deferred and re-deferred, in whole or in part, repeatedly and indefinitely until such time as all descendent components of the original loss are realized and remain subsequently un-deferred for 30 days. Such a pattern of wash sale adjustments is in fact the norm in actively traded accounts. Because of this fragmentation of original losses across multiple initial deferrals and subsequent re-deferrals, and dependant on the gaps and overlaps between relevant pairs of matched loss and replacement activity, it is quite possible under the holding period approach that some components of an original loss end up with short term treatment while others end up with long term treatment even when sold on the same day. Variable capital gains term treatment of a single original loss seems contrary to the intent of the wash sale rules, specifically that disallowed losses simply be carried forward until eventual realization, not transmuted in some way.
Further, wash sales are very sensitive to initial conditions, meaning that minor changes to adjustments early in the lifecycle of a deferred loss can lead to significant differences in later adjustments. Any modification of historical account activity (e.g. commission rebate, trade re-bill, cost basis update for transferred-in shares, after-the-fact changes to corporate action terms) will propagate through related wash sale adjustments, producing at best widespread recalculation of gain or loss and subsequent deferrals and at worst completely different deferral structures, where different sets of acquisition and loss activity are matched. Holding period computations may therefore also yield different results should even minor historical modifications be applied to account activity, potentially requiring numerous 1099-B and transfer reporting restatements.
Finally, holding period computations provide opportunity for significant abuse. Gaps between recurring loss and replacement activity may be engineered to extend the period over which losses are treated as short term by many years, and overlaps between one or more pairs of loss and replacement activity can in some circumstances be used to game long term treatment for short term gains. It is difficult to conceive that this is a desirable outcome.
In contrast, the holding date approach uses the acquisition date of an original un-adjusted loss to calculate capital gains term when any component of that original loss is eventually allowed (i.e. not re-deferred). Under this approach, the original acquisition date propagates unchanged through all descendant loss components, each of which receives identical term treatment upon final disposition. That is to say capital gains term is calculated for all components of a loss relative a single original acquisition date no matter the degree of fragmentation or the duration of deferral. All components closed on a single date receive identical treatment. Any and all components of an original loss closed within one year or less of the original acquisition date receive short term treatment, while any and all closed beyond one year receive long term treatment. Further, capital gains treatment remains constant regardless of activity patterns. No degree of change whether to individual gain or loss calculations or the entire deferral structure itself will impact term calculation upon ultimate disposition. Finally, since replacement share gaps and overlaps are irrelevant under the holding date approach, the potential for abuse discussed above does not exist.
While the language in 26USC1223(3) is open to interpretation, as is the statement on page 54 of the 2009 Pub 550, “Your holding period for substantially identical stock or securities you acquire in a wash sale includes the period you held the old stock or securities”, the statement within the section specifically devoted to wash sales treatment on page 56 quite clearly states, “Your holding period for the new stock or securities begins on the same day as the holding period of the stock or securities sold.” There is likely significant thought behind this second statement given its prominence, and it is our recommendation that this be the adopted holding period adjustment methodology for the reasons outlined.
Silver has found that significant confusion remains on this issue even among tax professionals. Clarification has been requested of the IRS rulemaking committee with the strong recommendation that the current language on page 56 of Pub 550 be formalized via a ruling setting forth that the adjusted holding period be determined by maintaining original acquisition date regardless of replacement share gaps or overlaps.