Scrubbing the Wash Sale Rules

Loss limitations are an ugly but inevitable feature of any realization-based income tax. In essence, because the system mismeasures gains, it also has to mismeasure losses. Otherwise, the timing option inherent in the realization rule would allow taxpayers to defer gains (thereby reducing the tax\u27s present value) while accelerating losses (thereby preserving the deduction\u27s present value). This strategic trading would erode the tax on risky positions, leading to inefficiencies as taxpayers developed a taste for risky positions, became locked in to appreciated positions, and sold loss positions they otherwise would keep. Distributional issues also would arise as the effective tax rate on capital income fell. In theory, we could address these problems by abandoning the realization rule but, for reasons of politics and administrability, this article assumes that the tax on gains cannot be accelerated. Instead, this article seeks to curtail the timing option by deferring losses