I sold partnership shares at an overall gain when including the "ordinary gain" then bought then back within 30 days. Is it a wash sale?

[BobinDC]

My initial reaction is that it is not a wash sale but unsure because the cost basis adjustment also includes a capital loss, which is smaller than the "ordinary gain" (which represents recaptured depreciation, thus taxed at a different rate).  

However, if this is a wash sale, how do I treat the "ordinary gain?"  Do I report it and pay the tax or do I allocate it to the cost basis of the replacement share and pay the tax when those shares are sold.  If I defer the "ordinary gain"by adding it too the cost basis of the replacement shares do I just commingle it with the allocated capital loss/  Or do I somehow segregate it and include it in the "ordinary gain" for the replacement shares when I sell them?  

[Lisa995]

I believe wash sales only apply to losses, not gains.
<a rel="nofollow" target="_blank" href="http://www.marketwatch.com/story/understanding-the-wash-sale-rules-2015-03-02">http://www.marketwatc...>

[BobinDC]

That's true, but what which "gain/"  When I sell shares in a partnership the "gain" on the sale consists of two parts: one from past depreciation (which reduced my cost basis) and another from what remains, which is characterized as a capital gain or loss.  

Maybe I'm overthinking this.  If I have a net gain on the sale, even if it is due to the "ordinary gain" exceeding a capital loss on the sale, the net gain appears to satisfy the language defining a wash sale.  

Unfortunately, that does not totally resolve the issue.  Suppose the capital loss exceeds the ordinary gain?  Then I clearly have a net loss and a wash sale.  The next issue is how do I allocate the disallowed loss?  When the replacement shares are sold they will have a cost basis consisting of four components:  (1) original purchase price (2) an ordinary gain due to past depreciation, (3) a capital gain (or loss) and the net loss disallowed by the wash sale, which itself will consist of two components (ordinary gain and a capital gain or loss.  

My question is do I add together the ordinary gain components and also add together the capital gains and losses but keep these two sums separate so that the former is entered on Form 4797 and the latter is entered on Schedule D?  This sounds logical because all of the recaptured depreciation is taxed at the 25 percent rate.  However, it require detailed record keeping.

The alternative is to just add the entire disallowed net loss to the original purchase price and lose the information regarding the recaptured depreciation.  I would think the IRS would oppose this as it allows that recaptured depreciation to be taxed potentially at the lower long-term cap gains rate.

Again, maybe I'm overthinking this.  But surely someone at the IRS has thought of this before me.

[Critter]

You are over thinking it...wash sales only apply to losses

[Rick19744 · Accepted solution]

A taxpayer cannot deduct the loss realized on the sale of stock or securities (including shares in a mutual fund) if the taxpayer purchases substantially identical stock or securities within the period beginning 30 days before and ending 30 days after the sale.  These rules apply if there is an overall loss.

In general, an interest in a partnership is not a stock or security.  While your facts don't indicate if this is a PTP (publicly traded partnership), a PTP interest probably does not follow the general rule.

Having said that, as noted above, the wash sale rules only apply when you have an overall loss.  You indicate you have an overall gain.  Partnership tax is complicated and especially when there is a sale involved and the partnership has Section 751 property (hot assets).  Based on your facts, this is the case for your interest.  Section 751 does not change the overall gain or loss.  It only impacts the character.

So by way of example: Let's say your overall gain is $10,000 but you have Section 751 gain of $15,000.  You will report the Section 751 gain on form 4797 as ordinary income.  Then to net to your overall gain of $10,000 you would also report a $5,000 capital loss on Schedule D and the applicable form 8949.  Just because you have a loss on this transaction reported on Schedule D does not mean you had an overall loss.  You still have an overall gain of $10,000.

So bottom line, the wash sale rules do not apply to your transaction.

[BobinDC]

Rick 19744,

Thank you!  That's the answer I was looking for.  

But suppose I have a net loss on the sale even including the Section 751 gain?  Don't I have a wash sale in that case?  If so, I have to allocate the disallowed loss to the replacement shares.  How do I treat the Section 751 gain?  Do I just carry it forward to the replacement shares and report it on Form 4797 when the replacement shares are sold?  

When I sell the replacement shares I will also have to adjust the cost basis of those shares using data supplied on my K-1 for that year.  This will include another ordinary gain.  Do I just add the ordinary gain associated with the disallowed loss to the ordinary gain provided on the new K-1?