In the previous post about cost basis reporting, the mention of a wash sale came up as being exempted.
So what is a wash sale?
I looked it up and here is what I found;
Wash Sales rule. If you buy replacement stock shortly after the sale — or shortly before the sale — you can’t deduct your loss.
When the value of your stock goes down you know you have lost money. US tax law does not allow that loss until you sell the stock. The problem is, you may have a conflict. You want to deduct the loss, but you also want to keep the stock because you think it’s going to bounce back. You might think that you can sell the stock to take the loss and buy it right back to keep it in your portfolio, but that is where the wash sale rule comes in. This rule is in place for 30 days.
So you have a wash sale if you sell stock at a loss, and buy substantially identical securities within 30 days before or after the sale.
Example: On March 31 you sell 100 shares of BCE at a loss. On April 11 you buy 100 shares of BCE. The sale on March 31 is a wash sale.
The wash sale period for any sale at a loss consists of 61 calendar days: the day of the sale, the 30 days before the sale and the 30 days after the sale. If you want to claim your loss as a deduction, you need to avoid purchasing the same stock during the wash sale period. For a sale on March 31, the wash sale period includes all of March and April.
Wash sale rules also apply if you enter into a contract or option to acquire stock. Or, if within that wash sale period, you sell a put option on the same stock that is “deep in the money”. You also have a wash sale if you sell options at a loss too.
The wash sale rule actually has three consequences:
- You are not allowed to claim the loss on your sale.
- Your disallowed loss is added to the basis of the replacement stock.
- Your holding period for the replacement stock includes the holding period of the stock you sold.
The basis adjustment is important: it preserves the benefit of the disallowed loss. You’ll receive that benefit on a future sale of the replacement stock.
Example: Some time ago you bought 80 shares of BCE at $50. The stock has declined to $30, and you sell it to take the loss deduction. But then you see some good news on BCE and buy it back for $32, less than 31 days after the sale.
You can’t deduct your loss of $20 per share. But you add $20 per share to the basis of your replacement shares. Those shares have a basis of $52 per share: the $32 you paid, plus the $20 wash sale adjustment. In other words, you’re treated as if you bought the shares for $52. If you end up selling them for $55, you’ll only report $3 per share of gain. And if you sell them for $32 (the same price you paid to buy them), you’ll report a loss of $20 per share.
Because of this basis adjustment, a wash sale usually isn’t a disaster. In most cases, it simply means you’ll get the same tax benefit at a later time. If you receive the benefit later in the same year, the wash sale may have no effect at all on your taxes.
The wash sale rule can also have truly painful consequences.
- If you don’t sell the replacement stock in the same year, your loss will be postponed, possibly to a year when the deduction is of far less value.
- If you die before selling the replacement stock, neither you nor your heirs will benefit from the basis adjustment.
- You can also lose the benefit of the deduction permanently if you sell stock and arrange to have a related person — or your IRA — buy replacement stock.
- A wash sale involving shares of stock acquired through an incentive stock option can be a planning disaster.
Some additional information on wash sales:
- You don’t have a wash sale unless you acquire (or enter into a contract or option to acquire) subsequently identical securities.
- You don’t have a wash sale, even though you bought identical shares within the previous 30 days, if the shares you bought aren’t replacement shares
- There are mechanical rules to handle the situation where you don’t buy exactly the same number of shares you sold, or where you bought and sold multiple lots of shares.
- If a person who’s related to you — or an entity related to you, such as your IRA — buys replacement property, your loss may be disallowed under a different rule: you may be treated as if you made an indirect sale to a related person.
- You don’t actually have to purchase stock within the wash sale period to have a wash sale. It’s enough if you merely enter into a contract or option to acquire replacement stock.
The wash sale rule only applies to losses. You can’t wipe out a gain from a sale by buying the same stock back within 30 days.
Plan around the wash sale:
While no technique is entirely safe and risk-free, here are some ideas to consider.
- Most obviously, you can sell the stock and wait 31 days before buying it again. The risk here is that the stock may rise in price before you can repurchase it.
- If you’re truly convinced the stock is at rock bottom, you might consider buying the replacement stock 31 days before the sale. If the stock happens to go up during that period your gain is doubled, and if it stays even you can sell the older stock and claim your loss deduction. But if you’re wrong about the stock, a further decline in value could be painful.
- If your stock has a strong tendency to move in tandem with some other stock, you may be able to reduce your risk of missing a big gain by purchasing stock in a different company as “replacement” stock. This is not a wash sale because the stocks are not substantially identical. Thirty-one days later you can switch back to your original stock if that is your wish. But there’s no guarantee that any two stocks will move in the same direction, or with the same magnitude.