Tax Planning for Losses
This newsletter is a brief follow-up to our recent year-end tax newsletter. Click here for our year-end newsletter. Since our 2018 year-end newsletter was distributed, the stock market has been very volatile and decreased significantly (although the market was up a lot today, December 26th, fortunately). Many funds may have significant unrealized losses. This newsletter elaborates on our year-end newsletter regarding realizing losses to mitigate taxable income. To paraphrase a saying, “try to make lemonade out of lemons.”
First, you should compare your taxable income with your book income, as many fund managers prefer to not have taxable income exceed book income. Second, you should review your portfolio for positions with material unrealized losses. Third, you should consider whether you should try to realize any of such losses in 2018 and the need to avoid the wash sale rules. Fourth, you should consider whether it would be preferable to delay realizing such losses until 2019. Fifth, you should consider whether it would be preferable to realize any gains in 2018.
Sales of stocks and securities are subject to the wash sale rules, meaning that you cannot sell stock at a loss and buy the stock back within 30 days. If you do so, the loss is disallowed.
Assets that are not stocks and securities are not subject to the wash sale rules. For example, if you sell bitcoin at a loss, you can buy bitcoin again without running afoul of the wash sale rules.
Selling stocks and securities at gains are not subject to the wash sale rules. So, you can sell stocks at a gain and immediately buy such stock again and the gain would still be realized. Also, gains on stocks and securities are subject to the constructive sale rules (conversely losses are not subject to the constructive sale rules).
There are planning techniques to avoid the wash sale rules. This newsletter very briefly sets forth some of the more common ways to plan around the wash sale rules.
One is to sell stock at a loss and then wait 31 days to buy the stock again. Another is to sell stock and then enter into a basket swap in which the sold stock is less than 70% of the basket and the basket has at least 20 stocks. Another is to sell stock, buy a call option on the stock, buy the stock, and then sell the call option. There are other potential tax planning methods as well. Some of the planning may depend on the positions on which you have losses.
2018 year-end tax planning is more complicated than in prior years, however. The excess business loss (“EBL”) rules are effective for 2018. The EBL rules apply at the partner level, and not at the fund level. Therefore, the fund could have significant excess business losses, but the partners may have other income that could offset the losses. If the EBL rule is a concern to a fund, the fund could also intentionally realize gains to decrease the excess business loss. If an investor has excess business losses (in excess of a threshold amount which depends on filing status), the excess is carried forward to 2019 as a net operating loss (“NOL”) and would be subject to an 80% limitation (the NOL could only offset up to 80% of income, and NOLs can no longer be carried back). Rather than generate an EBL in 2018, it might be preferable to wait to sell in 2019. Since the EBL rules are applied at the investor level, however, it might not be clear which is preferable. Adding to the complexity is the impact of the new limitation on the deductibility of interest by trader funds.
One other issue to consider is whether delaying the realization of losses (and gains) to 2019 in combination with a Section 475 election could be helpful to change the character of income/loss and/or to spread the income over a 4 year period.
With only a few days left in 2018, there is very little time to act. This newsletter just serves as a reminder after a volatile December.