Overview
Definition
Bed and breakfasting is a tax strategy where a shareholder sells a security at the end of the trading day and enters into an agreement with the broker to repurchase the same security at the opening of the next trading day. The primary goal is to establish a capital loss that can be used to offset capital gains for tax purposes.
Background
Previously, bed and breakfasting was a popular practice among investors, allowing them to crystallize a loss on a security without changing their overall position in the market. However, tax legislation reforms have imposed a 30-day requirement between the sale and repurchase of the same security, making this tactic inapplicable for shares.
Current Relevance
While bed and breakfasting has been effectively eliminated for shares due to the 30-day rule, similar strategies can be applied to other types of assets such as works of art. Investors may still utilize bed-and-breakfasting for these assets to optimize their tax liabilities.
Examples
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Example 1: Pre-legislation Change
- An investor sells 100 shares of Company X on December 31 for $10,000, realizing a loss of $2,000. On January 1, the same investor repurchases 100 shares of Company X. The $2,000 loss can then be used to offset gains realized from other investments during the year.
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Example 2: Post-legislation Change
- An investor, wishing to perform bed and breakfasting on Company Y shares, must now wait at least 30 days before repurchasing the same shares. Instead, the investor may consider selling and rebuying a piece of artwork, which is not subject to the same 30-day restriction.
Frequently Asked Questions
Why was the practice of bed and breakfasting restricted by tax legislation?
The practice was restricted to prevent investors from easily generating artificial tax losses without changing their market positions, which was seen as a loophole in the tax system.
What is the current waiting period required between the sale and repurchase of shares?
The current required waiting period between the sale and repurchase of shares to benefit from the tax loss is 30 days.
Are there any assets not subjected to the 30-day rule?
Yes, assets such as works of art are not subject to the 30-day waiting period and may still be used in bed and breakfasting strategies.
- Capital Gains Tax: A tax on the profit from the sale of property or an investment.
- Wash Sale: A sale of a security at a loss and repurchase of the same security within 30 days, disallowing the loss for tax deduction.
- Tax-Loss Harvesting: A method of selling securities at a loss to offset a capital gains tax liability.
Online Resources
Suggested Books for Further Studies
- “Taxation of Investment Operations” by Julia Kagan
- “The Investment Tax Starter Kit” by Andrew McEwen
- “Financial Intelligence: A Manager’s Guide to Knowing What the Numbers Really Mean” by Karen Berman and Joe Knight
Accounting Basics: “Bed and Breakfasting” Fundamentals Quiz
### What was the main objective of bed and breakfasting before legislative changes?
- [ ] To realize gains on investments.
- [x] To establish a loss to offset capital gains.
- [ ] To hedge against market volatility.
- [ ] To diversify investment portfolio.
> **Explanation:** The main objective of bed and breakfasting was to establish a loss that could be used to offset other profits, thus reducing the overall capital gains tax liability.
### What is the time period required between the sale and repurchase of shares to benefit from tax loss?
- [x] 30 days
- [ ] 1 day
- [ ] 7 days
- [ ] 14 days
> **Explanation:** Tax regulations now require a waiting period of at least 30 days between the sale and repurchase of the same shares to benefit from the tax loss.
### Which type of assets can still be bed-and-breakfasted without a 30-day restriction?
- [ ] Shares
- [x] Works of art
- [ ] Commodities
- [ ] Real estate
> **Explanation:** Works of art are not subject to the 30-day rule, meaning they can still be used in bed-and-breakfasting strategies.
### Bed and breakfasting is a strategy used primarily to manage what type of tax?
- [x] Capital gains tax
- [ ] Income tax
- [ ] Sales tax
- [ ] Property tax
> **Explanation:** Bed and breakfasting is primarily used to manage capital gains tax by establishing losses to offset gains.
### What was the consequence of the legislative changes to bed and breakfasting for shares?
- [ ] It increased its popularity.
- [ ] It made the practice more complex.
- [x] It made the practice obsolete for shares.
- [ ] It reduced the required time between transactions.
> **Explanation:** Legislative changes made the practice of bed and breakfasting obsolete for shares by imposing a 30-day waiting period between sales and repurchases.
### Can an investor still practice bed and breakfasting with commodities?
- [ ] Yes, commodities are not covered by the 30-day rule.
- [x] No, the 30-day rule applies to commodities.
- [ ] Yes, but only under specific conditions.
- [ ] No, due to intrinsic value differences.
> **Explanation:** The 30-day rule applies to commodities, making bed and breakfasting impractical for these types of assets as well.
### When does a wash sale occur?
- [ ] When a security is purchased within 14 days of a loss.
- [x] When a security is repurchased within 30 days.
- [ ] When earnings exceed a threshold.
- [ ] When dividends are reinvested.
> **Explanation:** A wash sale occurs when a security is sold at a loss and then repurchased within 30 days before or after the sale, disallowing the loss for tax purposes.
### What does the wash sale rule prevent?
- [ ] Offsetting profits with gains.
- [ ] Investing in similar securities.
- [ ] Hedging against volatility.
- [x] Creating tax-deductible losses through immediate repurchases.
> **Explanation:** The wash sale rule prevents investors from creating tax-deductible losses by repurchasing the same or substantially identical security within 30 days before or after the sale.
### In what year were changes to bed and breakfasting regulations implemented to enforce the 30-day rule?
- [ ] 2000
- [ ] 1996
- [ ] 2010
- [x] 2008
> **Explanation:** Significant changes to bed and breakfasting regulations were implemented in 2008 to enforce the 30-day rule.
### Why might a shareholder now prefer another asset type for bed and breakfasting?
- [x] Because other asset types do not have a 30-day restriction.
- [ ] Because shares yield lower returns.
- [ ] Because it reduces portfolio complexity.
- [ ] Because other assets are more liquid.
> **Explanation:** Shareholders might prefer other asset types like works of art for bed and breakfasting, as these do not have a 30-day transaction restriction.
Thank you for learning about the concept of bed and breakfasting. We hope this detailed guide, along with the quiz questions, enhances your understanding of financial taxation strategies.
