How to steer clear of the ATO if selling stocks for capital losses

Investors looking to offset capital gains tax bills often sell underperforming stocks in June. But there’s one strategy that can land you in hot water with the ATO.

Be wary of falling foul of the ATO’s ‘wash sale’ rules.

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It seems that some investors did not get the memo to “sell in May and go away”. The usual end-of-financial-year sellers have not dragged down the sharemarket. In fact, the ASX has done the opposite, rising steadily since its April lows after recovering from the shock of Donald Trump’s trade tariffs.

With only a few weeks until the end of the financial year, if you have significant realised capital gains, now is the time to get your act together and do some last-minute tax planning.

Maybe you recently sold CBA shares at their current lofty price or cashed in an interstate investment property for a tidy profit. Regardless of how you made the capital gain, if the investment was owned in your personal name and held for less than a year, full capital gains tax will apply at up to 47 per cent of the marginal tax rate. If owned for more than 12 months, discounted capital gains tax will apply at up to 23.5 per cent.

Not many people like to pay tax, and losing almost half of your profit from an investment especially stings. A popular strategy to help ease the tax burden involves selling loss-making investments and balancing the capital gains from profit-making investments, reducing the overall capital gains tax bill. Although there is nothing wrong with this and it is a legitimate tax-planning strategy, you do need to be careful about what the ATO refers to as “wash sales”.

A formal warning from assistant commissioner Tim Loh has been put out on wash sales.

“Don’t hang yourself out to dry by engaging in a wash sale,” Loh warns. “We want you to count your losses, not have them removed by the ATO.”

So what exactly is a wash sale?

Emile Koskinas, principal at accounting firm Empire Business Services, says it’s about what happens after the sale. “Wash sales are typically the disposal of an asset such as shares or crypto that will realise a capital loss and then after a short period of time the taxpayer acquires the same or similar asset such that the investment position is substantially the same,” Koskinas says.

The effect of the wash sale is to create capital tax losses that can be offset against capital gains in the same tax year, reducing the potential capital gains tax a taxpayer has to pay.

The ATO considers wash sales as tax avoidance under Part IVA of the Income Tax Assessment Act 1936, and considers that the taxpayer has obtained an unfair tax benefit. In other words, if you sell 100 BHP shares for a capital loss in June and then repurchase 100 BHP shares in July, the ATO’s wash sale rules are likely to apply.

The ATO says its data analytics can identify wash sales through access to data from share registries and crypto asset exchanges. When they identify this behaviour, the capital loss is rejected, resulting in an even bigger loss to the taxpayer.

Although wash sale rules prohibit you from selling and then repurchasing the same investment to claim the capital loss, there are situations where you may be able to conduct tax-planning strategies and stay on the right side of the rulebook.

What if you sold 100 BHP shares at a capital loss in June, but then purchased a 50-50 mix of BHP shares and a resources ETF such as VanEck Australian Resources ETF in July. Would this still fall under the wash sale rules and be disallowed?

Jordan Frieze, associate director at Accounting Advisor Group, says it wouldn’t. “The ATO’s view of wash sales is that a wash sale occurs where there is no significant change in a taxpayer’s exposure or interest in the same or a similar asset,” he says.

An asset is considered the same or similar to another where there are immaterial differences between the two such that they are economically similar. Two different investments, in this case BHP shares and a resources ETF, would not be considered substantially similar for these purposes, and would be unlikely to be seen as a wash sale.

Other situations that may fall outside of what constitutes a wash sale include changing between ETFs. With almost 400 ETFs available, there are multiple types from various providers that cover the same underlying basket of stocks such as the ASX 300 or the MSCI world index.

If you sell an ETF at a loss in June, and then purchase another ETF in July because the fees are cheaper, or it has a better tax treatment of income, this is unlikely to constitute a wash sale. However, intention is important and you should get advice before selling and buying similar investments.

James Gerrard is principal and director of financial planning firm www.financialadvisor.com.au