Ever looked at your share portfolio and thought.... "I've got an unrealised capital loss on some of my shares. Let's sell those shares, realise a capital loss and immediately re-buy the shares".
After all, this looks to be a great strategy to offset capital gains or book capital losses to save for the future.
Let's say you have two investments, as follows:
You invested $4,000 into Public Company 1, and the shares are now worth $5,000
You invested $5,000 in Public Company 2, and the shares are now worth $4,000
You want to sell the shares in Public Company 1, but don't want to pay the capital gains tax attached to the sale.
You want to keep holding Public Company 2 long-term, thinking the dip in share price is temporary.
So you sell the shares in both companies, offset the capital gain and loss against each other to pay no tax, and re-buy the shares in Public Company 2.
In theory it all sounds legit and like a great way to pay tax.....
The only problem is, the ATO prohibit it. (Damn they've thought of everything)
The ATO defines a wash sale in Taxation Ruling 2008/1 as:
"the sale and purchase of the same, or substantially the same, asset within a short period of time of each other.
The sale and purchase cancel each other out with the result that there is effectively no change in the economic exposure of the owner to the asset.
More generally, the expression wash sale is used to describe arrangements where a disposition of an asset occurs without an intention of ceasing to hold an economic exposure to the asset.
In this Ruling, however, the Commissioner is concerned with arrangements which have the effect of causing a disposition to happen which enables a taxpayer to incur a loss to offset against a gain already derived, or expected to be derived, in certain circumstances.
These being where owing to the manner, substance and timing of the events it may be questioned whether the loss making event is mainly to be explained by reference to the purpose of obtaining a tax benefit from the loss".The main aspects of the concern are when:
An asset is sold and an identical or similar asset quickly re-acquired
A tax benefit is achieved, generally through applying the capital loss against a capital gain
Following this process, the shareholder owns overall a similar asset position to before, but with the benefit of a capital loss.
When this happens, the ATO can take the view that a wash sale has occurred and a tax avoidance scheme exists.
The rumours are that the ATO uses sophisticated data collection and analytics to identify wash sales.
Ultimately, the ATO has the power to effectively reverse the tax benefit obtained.
Wash sales seem like a sound and legitimate way to save tax. Unfortunately it is a prohibited strategy, and little guidance is provided around how to avoid a wash sale occurring, especially around timeframes for selling and re-buying.
This leaves the criteria around a wash sale somewhat open for interpretation, which is less than ideal in terms of providing confidence to investors.
As always, we recommend you work with a professional advisor, put as much time between selling and re-buying as possible, and avoid selling and re-buying identical assets.
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