Tax Forum: Wash-Sale Rule Holds Up After Many Cycles

Also, paying future educational expenses, making up for a lost IRA payment and more.
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I hope you've thought of a clever Halloween costume. Apparently Austin Powers is a top pick for 1999. That's fine; anything's better than Monica Lewinsky.

But there's no masking the truth here at Tax Forum, so let's get down to business. We've got a quick update on

Nasdaq 100

tracking shares

(QQQ) - Get Report

and a lost Roth IRA contribution. In addition, we've got yet another wash-sale rule question (you can never get enough), and we'll fill you in on some great news on prepaying someone's education costs.

Any other questions? Send them to

taxforum@thestreet.com, and please include your full name.

More on the Wash-Sale Rule

OK. You can apply a loss disallowed by the wash-sale rule to the cost basis of the same security upon repurchase. Does that apply even if there is a loss on that trade? Even if you sell the security a second time and repurchase it within 30 days a third time? Even if the loss is applied toward a cost basis in the following calendar year? For example: I buy IBM (IBM) - Get Report at 120 on Aug. 20; sell at 90 on Oct. 21; buy at 85 on Oct. 22; sell at 100 on Nov. 1. Therefore, a gain of 15 per share is taxable. Now what if I purchase IBM at 95 on Nov. 3 and hold? Does this change the taxable gain stated above? -- Tamara Garrison-Garcia

Tamara,

The answer to your three questions is a resounding "yes."

To start, the wash sale applies only to losses, not gains. And regardless of how many times you buy and sell the same security, you must keep applying this same rule over and over again.

Remember, the essence of the wash-sale rule is that if you sell your security at a loss and repurchase the same security within 30 days of that sale, you can add that loss to the basis of the new purchase. The calendar years don't matter. Check out this

monster story for more on the wash-sale rule.

Now let's go to your example: We'll assume you're repurchasing and selling equal lots of IBM.

The $30 loss generated from your Oct. 21 sale is disallowed because you repurchased the same stock the next day. You must carry the loss forward to the next transaction. So when you buy for $85 on Oct. 22, your basis is really $115 (85+30), notes Ted Tesser, trader tax specialist and author of

The Trader's Tax Survival Guide

.

When you sell at 100 on Nov. 1, you have a $15 loss -- not a gain -- because the basis was adjusted. But you can't take that loss either because you purchased the stock again on Nov 3.

So your $15 loss is added to the basis of the Nov. 3 purchase, bringing your basis to $110 (95+15), which you'll carry into the new year since you've decided to hold.

I know this seems confusing, but if you just take it one step at a time, it won't seem so overwhelming.

Footing Future Education Bills

Thanks to a recent technical advice memorandum from the

Internal Revenue Service

, you can now prepay education costs for someone well into the future.

The gift-tax rules say that as long as the tuition is paid directly to the institution, there is no tax on the gift, regardless of the amount. But the popular notion has been that the tuition paid was for the current academic year.

But thanks to a very generous grandma, things have changed.

In 1994, a grandmother decided to prefund 12 years worth of school for her grandkids. She made a series of tuition payments to their private school, for preschool through 12th grade.

The IRS challenged her eligibility for a gift-tax exclusion, arguing that she wasn't really paying anything since her grandkids were not in those grades yet, says Martin Nissenbaum, national director of personal income-tax planning at

Ernst & Young

.

But after debating the question internally, the IRS agreed with Grandma. Because the payments were made directly to the educational organization and were to be used exclusively for the payment of specified tuition costs for the grandkids, the IRS concluded that the grandmother's payments did indeed qualify for the gift-tax exclusion, according to the memorandum.

This is great news for grandparents (or anyone) trying to get money out of their estate.

Better Luck Next Year

I opened a Roth IRA before April 15, 1999 for the 1998 tax year. My check for $2,000 was returned, but I didn't realize until a few days ago. The broker did not redeposit the check although this is generally done by many institutions. How can I salvage my lost opportunity to add $2,000 to my 1998 Roth IRA? -- Marat Reddy

Marat,

Most brokers are very anxious to get your money and deposit it. Frankly, they want the commissions. So it's odd that your check was not redeposited.

Trying to prove that you made the 1998 contribution will be a challenge. Just having a check dated pre-April 15 won't hold much weight with the IRS. "It's very easy to write out a check now and date it April 15," says Clarence Kehoe, partner and director of employee benefits at

Anchin Block & Anchin

, a New York accounting firm.

Your best bet is to have the brokerage firm admit it made a mistake (good luck!) and provide documentation to prove your contribution was valid for 1998, not 1999.

What's New With the QQQ?

Back in May, we

reported that the IRS had yet to figure out how to tax gains and losses from QQQ options trading.

The reason for the uncertainty was this: Should options on the QQQ be taxed like options on regular stocks or should they be treated as index-based options and taxed under the 60/40 rule? (That rule says that 60% of the gain or loss is taxed at the long-term capital gains rate and the remaining 40% is taxed at the short-term rate, regardless of how long the option is held.)

Many of you have written in asking what's new on this front? "Absolutely nothing," says Richard Shapiro, an Ernst & Young securities tax partner in New York. The IRS has not made a decision and no one knows when to expect one.

Comforting, isn't it?

TSC Tax Forum aims to provide general tax information. It cannot and does not attempt to provide individual tax advice. All readers are urged to consult with an accountant as needed about their individual circumstances.

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