A Message from Kimberly Clouse, Financial Expert:
I have worked in the financial services industry for nearly a decade in many capacities, most recently as a financial adviser for individuals. Over the course of my career, I have had the privilege of working with a diverse range of people, from the single mother just starting her own business to the dot.com billionaire. Based upon my experiences, I have learned that the same basic principles and lessons apply to a successful and healthy financial life, whether you’re starting out or cashing out. These guiding principles include simplicity, a long-term perspective, and above all, knowing that you have control of your financial destiny, and all the information you need is well within your reach.
What is the Wash-Sale Rule?
Consider this scenario: On October 31st, you sell 100 shares of Acme Halloween Company at a loss. On November 10th, a television report claims that Halloween decorations will be all the rage this Thanksgiving, and you buy 100 shares of Acme Halloween on November 11th. Enter the wash-sale rule. If you sell Acme shares on October 31st, and buy them back within 30 days, the Internal Revenue Service (IRS) will not allow you to deduct the loss on your tax return. Since the IRS allows taxpayers to use losses to offset unlimited capital gains and up to $3,000 of other income, it is certainly worthwhile to consider selling losing stocks from a tax perspective, but be mindful of the restrictions.
A wash sale is defined as the purchase and sale of a security either simultaneously or within a short period of time. Wash sales taking place within 30 days of the underlying purchase do not qualify as tax losses under the IRS rules. The wash-sale rule prohibits investors from selling a security to create a loss and then quickly repurchasing substantially identical securities within 30 days before or after the sale. Therefore the wash-sale period for any sale at a loss consists of 61 calendar days: the 30 days before the sale, the sale date, and the 30 days after the sale. In the above example, for an October 31st sale, the wash-sale period includes all of October and November, and, consequently, the October 31st sale would be deemed a wash sale. If you waited until December 1st to buy the replacement Acme Halloween shares, you would no longer fall in the wash-sale period and could have taken the tax loss for the October 31st transaction.
The definition of “substantially identical securities” is not hard and fast, but the underlying concept is that risk and wash sales are inextricably linked. If you are able to create a strategy that totally eliminates the potential downside from your sale and repurchase transactions, then you will likely have a wash sale. In general, the stocks of two companies in the steel industry are not considered to be substantially identical; however, if the price performance of these two stocks were linked in some way, then you would probably fall into wash-sale territory. Since the rule applies to “securities,” wash-sale situations can occur even if you do not acquire stock but instead enter into an option contract to purchase replacement shares. (An option is the right to buy or sell property that is granted in exchange for an agreed upon sum.) Accordingly, you can trigger a wash sale from selling options at a loss.
The wash-sale rule is particularly important as you plan for taxes generated from your investment portfolio. But the wash-sale rule applies only to losses, and you cannot eliminate a gain from a sale by buying the same stock back within 30 days. Of course, taxes should never be the primary reason behind investment decisions, so always consider the long-term value of the stock and weigh that against the benefit you will receive by claiming a deduction for the loss. If you do find yourself in a wash-sale situation, consult your accountant or financial adviser, as the consequences of the wash-sale rule can also impact the basis (typically the purchase price of the shares) and holding period of the replacement stock.
This column is designed to provide accurate and authoritative information on the subject of personal finances. It is provided with the understanding that the Author is not engaged in rendering legal, accounting, or other professional services by publishing this column. As each individual situation is unique, questions relevant to personal finances and specific to the individual should be addressed to an appropriate professional to ensure that the situation has been evaluated carefully and appropriately. The Author specifically disclaims any liability, loss or risk which is incurred as a consequence, directly or indirectly, of the use and application of any of the contents of this work.