Holding Period Change after Wash Sale
Let’s start with a quick review of what a Wash Sale is.
The loss from the sale or disposition of stock or options is not deductible if, within a period beginning 30 days before or 30 days after the sale that generated the loss (a 61-day window), the investor acquires substantially identical shares or contracts or acquires a contract or option to buy substantially identical stock. (IRS Publication 550)
Wash sales ONLY apply to losses. Therefore, if there is a gain on the disposition of stock or options, by definition there is no wash sale.
Basis - the cost basis of the newly acquired stock or option that triggered the wash sale is INCREASED by the disallowed loss.
Holding period - the holding period begins for the new stock or option on the same day as the securities sold.
These are complicated calculations which are exacerbated when options are exercised or assigned during the course of a trade.
As noted elsewhere on this website, IRS publications cannot be relied upon by taxpayers for tax return positions. Go figure … ?
So what is authoritative? According to TC Summary Opinion 2014-14, the only sources of authoritative Federal tax law are the applicable statutes, regulations and judicial decisions, citing Zimmerman v Commissioner, 71 TC 367, 371 (1978).
So what do the statutes say about the holding period of wash sale shares?
IRC Sec 1091 is the authoritative guidance for wash sales. There it states that if a loss is disallowed because of the wash sale rules, the taxpayer adds the disallowed loss to the cost basis of the new stock or securities (except in wash sales involving the taxpayer's IRA or Roth IRA).
Further, regarding the new holding period, the holding period for the new stock or securities begins on the same day as the holding period of the stock or securities sold. [IRC Sec 1223(3); Rev Rul 71-520]
In determining the period for which the taxpayer has held stock or securities the acquisition of which (or the contract or option to acquire which) resulted in the nondeductibility (under section 1091 relating to wash sales) of the loss from the sale or other disposition of substantially identical stock or securities, 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. [Emphasis mine]
So what does that mean?
You purchase shares in ExxonMobil (XOM) on August 19, 2016 via the sale of a cash-secured put with a strike of $90. You received $2.00 for the sale of the put so your tax basis is $88 ($90 strike - $2 short put premium received).
On June 16, 2017 you sell XOM for $82.50 as a result of a short call exercise and you received $1 for the sale of the call. Thus, your gross proceeds are $83.50 ($82.50 strike + $1 call premium received).
You had been selling calls each of the intervening weeks and/or months but the premium from those do not impact the cost basis or proceeds of the sale of XOM.
Now, your tax loss on the sale of XOM is $4.50 ($82.50 strike + $1 call premium less the purchase price of $90 - $2 for the put premium).
You immediately sell another put for the next month at a strike of $82.50. The sale of the short put makes this a wash sale (see Substantially Identical Securities discussion) but you are also assigned the shares of XOM because it closes at $80.12 on July 21, 2017.
When does your holding period begin ... July 21, 2017, July 22, 2017, August 19, 2016 or another date?
For an assignment, the normal holding period begins the day AFTER the exercise or assignment date. So on the original assignment of shares the holding period begins on August 20, 2016. And typically the holding period on the newly assigned shares would be July 22, 2017, BUT there is a wash sale involved.
Your holding period for the October 16, 2015 actually looks back to the day the SOLD shares were originally purchased, or August 19, 2016. So now your holding period is Long-term NOT Short-term.
IRS Pub 550 states: "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."
Now, how long does the investor/trader "hold" the stock or securities in this example? My interpretation of this is that the period from the exercise of the short call (June 16, 2017) to the assignment of the short put (July 21, 2017) is NOT part of the holding period because the stock was not actually "held" on those days. Therefore, the holding period dates back to September 24, 2016, calculated as follows:
Assignment date ..... 8/19/2016
Holding period start date ..... 8/20/2016 (for original assignment)
Exercise date ..... 6/16/2017
Assignment date ..... 7/21/2017 (35 days after the Exercise date, period stock NOT held)
Holding period start date ..... 9/24/2016 (Original holding period start date + 35 days stock NOT held)
Is this advantageous for a trader? Maybe but maybe not. Remember, all long-term transactions are netted then all short-term are netted and then those are netted together to determine capital gain or loss. If a loss, then only $3000 may be deducted against ordinary income, if no Mark-to-Market election is in place.