- quote -

That's not necessarily true. The loss in one account is
making an equal gain in the other, and perhaps the
loss-making counterpart has to exist for the gain to occur.
Therefore, even if you know in advance which account is
going to take the loss, there is no arbitrage possible.

I have a gut feeling that there does exist such a
transaction, though the exact mechanics I haven't figured
out yet. My hypothesis is that one can eliminate the risk
of the underlying security, and instead rely on the
predictible decline in option value of a derivative.

The crux of the issue is that if it does exist, then it has
tremendous consequences for the IRS and current tax policy.
On the other hand, since no one here knows about it, and the
IRS doesn't have rules against it, then that strongly
suggests it doesn't exist, and that it is just another
perpetual motion machine idea.

- quote -

I'm only considering legitimate, publicly available
transactions.

<< -------------------------------------------------> << The Charter and the Guidelines for submitting > << messages to this newsgroup are at www.asktax.org > << ------------------------------------------------->

Shailesh Humbad <humbads1[at]hotmail.com> wrote:

- quote -

No; it's easy to create a risk-free transaction to move
money between two accounts, but you can't predict which
account will gain and which will lose. After all, if you
could, why bother doing the losing side of the trade at all?

- quote -

The only technique that works reliably to move the money in
a known direction involves fraud, and it isn't the IRS you'd
have to worry about, it's a much much nastier agency.

Seth

<< -------------------------------------------------> << The Charter and the Guidelines for submitting > << messages to this newsgroup are at www.asktax.org > << ------------------------------------------------->

Suppose a person, John Doe, holds $10,000 in a taxable
investment account, and $10,000 in a non-taxable Roth IRA
investment account. During the year, John's taxable
investment incurs a loss of $1,000, while the Roth IRA
investment gains $1,000. Overall, at the end of the year,
John's net balance is identical, ignoring transaction costs.
The only change is that $1000 has been, in effect,
transferred into the Roth IRA.

But what is the tax consequence? As you know, gains in a
Roth IRA are not taxable while they remain in the account.
However, a person can deduct an unlimited amount of capital
losses against capital gains in taxable accounts. Additional
losses up to $3,000 per year can be deducted from ordinary
income, with the remainder rolled over to future years.
Therefore, if John has no other investments and is in the
28% tax bracket, he can lower his taxes by $280 by deducting
the $1000 capital loss from his gross income.

Gains on funds in a Roth IRA are not taxable if withdrawn
after the account holder reaches age 59 1/2. Therefore, if
John withdraws the $1,000 gain after that age, he has in
effect avoided taxes entirely on that $1,000 of income. If
John otherwise doesn't need those investment funds, then any
losses in his taxable accounts that are matched by gains in
his Roth IRA accounts provide him with a tax benefit, up to
the limits for capital loss deductions.

Given this circumstance, I believe it would be possible
using options to design a relatively risk-free transaction
where John incurs a loss in one account (taxable) and a
commensurate gain in another account (non-taxable). I
believe it could be done without running afoul of the rules
for wash sales and "straddles" listed in IRS Publication
550, which seem to apply only to taxable investments.

This is essentially a way to either delay taxation or avoid
it entirely, by using a backdoor Roth IRA funding mechanism.
Is the logic of this loophole valid? Has anyone
encountered this before? Does the IRS have an opinion on
taxpayers using this strategy to avoid taxes on capital
gains and income?

Regards,
Shailesh

<< -------------------------------------------------> << The Charter and the Guidelines for submitting > << messages to this newsgroup are at www.asktax.org > << ------------------------------------------------->