Calculating Adjusted Holding Period

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.

6 Responses to Calculating Adjusted Holding Period

  1. Thomas McLeod says:

    The problem with your analysis is that holding date method does not accurately reflect the length of time one actually holds shares. In an actively traded account, the first match during the wash sale period is usually on the 30th day prior to the sale. That means for every wash sale up to 30 days of holding time is lost. This will cause some shares cumulatively held over one year to appear as short-term. This problem does not occur with the holding period method.

    Regarding your observation that “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,” why is this a problem? If this happens, it reflects how long individual shares were actually held.

    Finally, it is also possible to game the holding day method. By repeatedly buying and selling on the same day at 30-day intervals until the stock realizes a gain, one can claim a long term gain even though the stock was never held overnight.

    • N Ruskin says:

      Thank you for your comments, Thomas — it’s great to see others thinking constructively about this issue. I’d be interested in your thoughts about the following:

      The problem with your analysis is that holding date method does not accurately reflect the length of time one actually holds shares.

      The length of time one actually holds shares is not the only factor in determining holding period. In fact, in cases where other factors come into play (e.g. Secs 1233, 1259, 1092), holding period rarely reflects the number of days shares are actually held. For example, an investor buys shares on Jan 1, 2011, sells short an equivalent quantity of the same stock on Feb 1, 2011, closes the short on Mar 1, 2011, then on Jan 2, 2012 sells the shares acquired on Jan 1, 2011 — the shares are actually held for 366 days, which is normally sufficient to qualify for long-term treatment, but due to Sec 1233(b)(2) the investor must treat the gain or loss on the shares as short-term per an adjusted holding period of 308 days (the period from Mar 1, 2011 through Jan 2, 2012). There’s no reason adjustments to holding period under Sec 1091 should be treated any differently — that the adjustments result in a holding period that does not reflect the length of time one actually holds shares is to be expected.

      In an actively traded account, the first match during the wash sale period is usually on the 30th day prior to the sale. That means for every wash sale up to 30 days of holding time is lost.

      To express this as a concrete example, assume an investor buys 100 shares of stock on Jan 1, buys another 100 shares of the same stock on Jan 2, then on Feb 1 sells the first 100 shares at a loss, which is disallowed by the acquisition on Jan 2. The ‘holding date’ method would adjust the holding period of the Jan 2 shares to begin on Jan 1, the same day as the holding period of the shares sold.

      You’re saying this result loses 30 days of holding time. This would be the case if the overlapping period (during which both the original and the replacement shares were held) from Jan 2 through Feb 1 is meant to be double counted (once for the original shares and again for the replacement shares). However, it’s very hard to justify double counting overlaps. A capital asset accrues holding period when exposed to risk of loss (Secs 1233, 1259 and 1092 serve to suspend or reset holding period when an asset is not exposed to risk of loss). Two blocks of stock held concurrently over the same period represent independent assets which can’t be considered to accrue twice the holding period simply by considering them together. If “cumulative” holding period were allowed, a taxpayer could claim that 12 blocks of 100 shares of company X purchased independently on Jan 1 then all sold on Feb 1 should receive long-term treatment since they were cumulatively held for 372 days (12 blocks, each held for the 31 days from Jan 1 through Feb 1). No one would seriously claim this, and yet this is exactly what the ‘holding period’ method does when double counting overlaps. In our opinion, the ‘holding period’ method is only defensible when overlaps are single counted. Doing so yields results identical to the ‘holding date’ method which ignores (i.e. single counts) overlaps by design — in either case, no holding time is lost.

      By repeatedly buying and selling on the same day at 30-day intervals until the stock realizes a gain, one can claim a long term gain even though the stock was never held overnight.

      This point deals with gaps during which neither original or replacement shares are held. Under the ‘holding date’ method, gaps are also ignored by design, meaning that gaps are counted when determining the adjusted holding period of replacement shares. As discussed above it is quite common for adjusted holding period to bear no relation to how long shares are actually held, so there’s nothing inherently improper about a long term result when shares are never held overnight.

      The wash sale rule is intended to “prevent a taxpayer’s taking losses for tax purposes while giving up his position in a security for only a few days or not at all” (see the discussion of Congressional intent in Rev Rul 56-602). Effectively, a taxpayer may realize a tax loss only by forfeiting equivalent exposure to gain or loss for a sufficient period determined by Congress to be 30 days. In this example, the investor never forfeits more than 29 days of exposure, and therefore the rules treat this as an effectively continuous exposure. Since an exposed asset accrues holding period, and since original shares and their replacement shares together represent an effectively continuous exposure, it makes sense to consider the holding period of the replacement shares as beginning on the same day as the holding period of the original shares. This is the reasoning behind the treatment of gaps under ‘holding date’ method. The ‘holding period’ method on the other hand does not count gaps and thereby does not consider original and replacement shares as an effectively continuous exposure — this treatment is very likely contrary to the intent of the wash sale rule. In fact, your example nicely illustrates the kind of abuse the ‘holding period’ method permits: By repeatedly buying and selling at a loss at 30-day intervals a taxpayer could extend short-term treatment of a loss indefinitely (and without tying up capital!), bypassing tax years with net long-term gains until the loss can be used to offset a net short-term gain. This is equivalent to converting short-term gains to long-term gains, an outcome prohibited by various sections of the Code.

      Ultimately, the ambiguity as to how to adjust holding period for wash sales stems from the language of Sec 1223, specifically paragraph (3) pertaining to Sec 1091 which states “there shall be included the period for which he held the stock or securities the loss from the sale or other disposition of which was not deductible”. Regardless of the problems discussed above, a literal reading could easily lead one to not count gaps and to double count overlaps as you’re suggesting. However, in all other cases where the phrase “shall be included the period” or similar appears in Sec 1223 and related regulations, the circumstances (e.g. exchanges, involuntary conversions, various distributions, rights exercise, commodity futures settlement) afford no gaps or overlaps between original and successor positions. Only under the wash sale rules can gaps and overlaps arise, so it is understandable that similar phrasing would be applied in reference to Sec 1091 by drafters lacking an intimate understanding of wash sale mechanics. Unless and until there is guidance one way or the other, approaches to adjusting holding period can justifiably vary with a significant impact on outcome.

  2. Candi Ince says:

    “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.”

    Has the IRS responded to this request for clarification?

    • N Ruskin says:

      Not yet — there’s no guidance pertaining to the mechanics of wash sales in either the final 2011 regulations or the proposed 2014 regulations. Judging from investor outcry (see here, here, and here), it’s clear the lack of a standard is causing problems — I’d have to assume that either the industry will arrive at a consensus (though this does not appear to be happening) or guidance eventually will be issued.

    • msf says:

      It appears that the IRS has responded, albeit with a clarification opposite to the one requested.

      Pub 550, under Wash Sales (p. 56) in 2009 had read: “Your holding period for the new stock or securities begins on the same day as the holding period of the stock or securities sold.”

      The current (2012) Wash Sales section (now on p. 59) reads: “Your holding period for the new stock or securities includes the holding period of the stock or securities sold.”

      So it appears the IRS has internally harmonized Pub 550 by going the other way in its clarification.

      • N Ruskin says:

        This specific language in Pub 550 was changed to its current form in the 2010 version. Unfortunately the change cannot be taken as official guidance since IRS Publications are non-authoritative — while the current Pub 550 language may give a hint of IRS intent, it cannot be used to guide tax court rulings (see http://www.irs.gov/Tax-Professionals/Tax-Code,-Regulations-and-Official-Guidance). Without official guidance in the form of a revenue ruling or updated regulations the ambiguity remains, and brokers are free to choose one method or the other (as well as one of several treatments for gaps and overlaps when choosing the holding period method — see above).

        Silver’s position is unchanged — we feel the IRS, taxpayers, brokers and vendors would be best served if the holding date method were officially adopted. Should the holding period method be adopted instead, our hope is that guidance would include specific direction as to the treatment of gaps and overlaps. Until this and other similar issues are resolved, vendors are left to support multiple methods, and brokers can reasonably report different results for even trivial fact patterns.

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