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Stocks & Investing: The Wash Sale Rule

March 8th, 2011
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03.08.2011 original publish date
03.24.2014 minor update

Stocks & Investing: The Wash Sale Rule

Investor Education Series by Net Advisor

If you are new to investing or trading, or plan to sell an investment you own at a loss and buy it back later it is important to understand the IRS’s Wash Sale Rule.

What is the Wash Sale Rule?

According to the IRS:

“A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale you:

  1. Buy substantially identical stock or securities,
  2. Acquire substantially identical stock or securities in a fully taxable trade,
  3. Acquire a contract or option to buy substantially identical stock or securities, or
  4. Acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA.

If you sell stock and your spouse or a corporation you control buys substantially identical stock, you also have a wash sale.”

— Source: IRS Publication 550

Why is the Wash Sale Rule Important?
One cannot deduct losses from the sale of stocks (securities) or other qualified investments under the Wash Sale Rule. Normally if one has a loss on their qualified investment (stocks, bonds, options, mutual funds, hedge funds, private investments, etc.) per IRS rules, one can deduct those losses against gains earned in the same tax year. If the investment losses are greater than the investment gains, one can generally write off a small part of those losses against their ordinary income in the same tax year. The remaining losses can generally be carried over into future tax years and deduct those losses in the same manner until the losses are zero.

Quiz: Which of the following might be a wash sale?
(1) Buy XYZ stock June 15, 2009 at $10/share.
(2) Sell XYZ stock March 15, 2010 at $30/share.
(3) Buy XYZ stock March 22, 2010 at $25/share.
(4) Sell XYZ stock April 2, 2010 at $23/share.
(5) Buy XYZ stock May 1, 2010 at $22/share.

Breaking Down these Trades to Determine a Wash Sale:
(1) Buy XYZ stock June 15, 2009 at $10/share.
(2) Sell XYZ stock March 15, 2010 at $30/share.

Answer: This trade is not a wash sale. The net result is a gain ($20/ share).

Next Trade:
(3) Buy XYZ stock March 22, 2010 at $25/share.

Answer: This buy did not cause a wash sale because the previous transaction (1) & (2) above resulted in a gain.

(4) Sell XYZ stock April 2, 2010 at $23/share.

Answer: This sell trade #(4) did not cause a wash sale. It is just a tax loss.

Next Trade:
(5) Buy XYZ stock May 1, 2010 at $22/share.

STOP: Remember, trade #(3) was purchased at $25.00 on March 22, 2010, then sold at $23.00 on April 2, 2010 creating a $2.00 loss per share ($25 purchase – $23 sell = $2.00 loss per share). Because the investor bought back the same stock again within 30 days of the last sell date (April 2, 2010), this trade is subject to the Wash Rule. Thus the investor cannot write off the #(3) & #(4) trade as a tax loss.

Even if the investor makes a profit on the May 1, 2010 purchase at $22/share and sells that stock at say $23 per share, the investor still cannot write off #(3) & #(4) trade as a loss.

How to Avoid the Wash Sale
1. If you buy a stock or security (investment) that resulted in a loss, wait 30 days before buying substantially the same security again. One should wait 30 + 1 days. The rule is, one cannot write off any repurchase of substantially the same security within 30 days, thus you really have to wait one day past 30 to avoid the Wash Rule.

2. If you really want to buy the security again within 30 days make the purchase in a different type of account such as an IRA, Roth IRA, other qualified retirement account, a joint account, kid’s account (529 plan, custodial account), or a trust, etc., as long as the loss didn’t occur in another same type of taxable account.

3. You can always repurchase securities and not be subject to the Wash Rule in an IRA, 401(k), or any tax qualified retirement account. Just remember if you lose money in a retirement account, you don’t get to write off the loss, you just loose the money.

If you need investment help, please see a professional financial advisor. For tax questions, always seek a professional tax advisor. Unless you stock broker is also a CPA, they are generally prohibited from giving tax advice.

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Please be reminded that information above is not to be deemed as tax, financial or legal advice. The links herein are provided for reference. Tax and securities laws may be subject to change.  Always seek a professional tax advisor before engaging in tax related issues.

Image: Base image of persons public domain. Modified image by NetAdvisor.org purely for humor as a play on wash sales.

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Stocks & Investing: The Wash Sale Rule

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