Q Dear Rick:
I have a tax problem that I hope you can help me with. In 2014 on the advice of my broker I bought a stock. I paid $10 a share and the broker said he thought the stock would double or even triple within a year. Unfortunately, the exact opposite happened. The stock went from $10 a share to about two dollars a share. The broker told me that he still had confidence in the stock and he recommended that I sell the stock so I could deduct my losses for tax purposes and then to rebuy the stock. At the time he told me that I need to wait at least three days before I rebuy the stock. That is exactly what I did. On my 2015 tax return I deducted the losses. A few weeks ago I received notice from the IRS that they have denied my loss and as a result, I owe them money. I contacted the IRS and they told me I was in violation of the wash-sale rules. My first question to you is, is the IRS correct? I remember reading one of your articles where you said that the IRS makes mistakes as well and that just because they say you owe money doesn’t mean you do. My second question is that if I do owe money do you think the broker should pay it? You should know that the stock did not rebound; it continued to fall and I sold it this year for a little over a dollar a share.

I knew the risk involved with the stock and I accept responsibility for not only buying the stock in the first place, but in rebuying it again. I took a gamble, I lost and I’m fine with that. The interest I have to pay to the IRS is no big deal. The penalty, on the other hand, is what I’m more concerned with. I think in principle I should not be responsible for this. I’m not going to hire a lawyer or anything of that nature. My philosophy is why put good money after bad.
Help.
Al

A Dear Al:
I always hate it when the IRS is correct and unfortunately, in this situation they are. The wash-sale rules are means to prevent the exact transaction which you did. Therefore, the IRS is correct in that you should not have taken the losses and thus, you owe the taxes.

When it comes to the wash-sale rules, the rule says that in order to deduct a loss on the sale of stock you cannot rebuy the same stock 30 days before the sale or 30 days after the sale of the stock. Since you did buy the stock within that 60-day window, 30 days before and 30 days after, you fell within the wash-sale rules and thus, you are not entitled to deduct the losses. However you will be able to deduct the loss on your 2016 return.

The issue with regard to the broker is a trickier question. Yes, the broker should have been aware of the wash-sale rules and should have informed you. However, because you eventually sold the stock and will take the losses as a deduction, they are probably not liable for your tax liability. That being said, I do believe they should be responsible for the penalty. The penalty, unlike interest (which is a function of time), is meant to punish someone for not complying with tax laws. Since the broker gave you bad advice, I believe they should be responsible for the penalty.

As you said in your letter, the dollar amount is not substantial enough that it pays to hire an attorney. However, if they won’t pay the penalty, there are other avenues. For example, the brokerage firm may have some sort of arbitration procedure you can pursue and, you can also contact state and federal regulatory agencies to file a grievance.

What I find refreshing about this readers scenairo is the fact that he is taking some responsibility. He recognizes that he took a gamble and lost. I certainly am not in favor of investors gambling with their investment dollars; however, if someone wants to take a flier on something they need to understand the consequences and the risks involved. I generally tell investors that if they want to take a gamble on an investment, that’s fine; however, they need to determine whether losing all of the money will have a material effect. If it does, they ought to walk away.

Good luck!
Rick is a fee-only financial advisor. His website is www.bloomassetmanagement.com. If you would like Rick to respond to your questions, please email Rick at rick@bloomassetmanagement.com