Understanding wash sales is crucial for investors looking to maximize their tax benefits while managing their investment portfolios. Yet for many taxpayers, this terminology isn’t exactly clear. Running through the breakdown of how wash sales work—along with their implications for your taxes—can help ensure you’re in the clear!
Know Your Tax Terms: Wash Sales
On the basic level, a wash sale occurs when an investor sells a security or trades stock at a loss, and then decides to repurchase the same security within 30 days. That might sound simple enough, but the IRS has a few additional items to check. The 30-day limit actually extends to “before or after the sale,” and you’ll be held to the wash sale rule if any of the following actions take place:
- You bought a substantially identical stock or security within 30 days before or after you sell or trade stock or securities at a loss
- You acquire substantially identical stock or securities in a fully taxable trade
- You acquire a contract or option to buy substantially identical stock or securities
- You acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA
The 30-day rule is the cornerstone of the wash sale rule. Because if you buy back the same or a substantially identical security within 30 days before or after selling it at a loss, the loss is disallowed for tax purposes. Instead, the disallowed loss is added to the cost basis of the repurchased security.
The Backstory on the Wash Sale Tax Rule
The IRS designed wash sale rules to prevent taxpayers from claiming a tax deduction for a security sold in a wash sale. For example, if someone bought 100 shares of XYZ stock for $10,000 and then sold them for $9,000, they would be realizing a $1,000 loss. But if they ended up repurchasing 100 shares of XYZ stock within 30 days, the $1,000 loss is disallowed.
Booking a loss for tax reasons is solid, but when investors are selling stock they like, just to turn around and repurchase shares of the same company, then the IRS flags that under the wash rule. Going back to the example, rather than book the short-term loss on the desired company, the investor would need $1,000 to be added to the cost basis of the new shares, making the new cost basis $10,000. No more purchasing replacement shares just to book short-term losses. That’s the wash rule.
Next Steps for Booking Your Stock Losses
When a wash sale occurs, you cannot claim the loss on your taxes for that year. Instead, the loss is deferred and added to the cost basis of the repurchased security. This adjustment increases the cost basis, which can reduce your capital gains when you eventually sell the repurchased security.
If you want to avoid triggering a wash sale, then you have a few strategies. First, check your dates. You need to make sure you wait at least 31 days before repurchasing the same or a substantially identical security. Otherwise, look into purchasing securities that are not substantially identical to the ones you sold. Then you can claim the loss without being at risk of the wash rule.
Understanding the IRS wash sale rules is essential for effective tax planning and investment management. But the system isn’t always easy to navigate! If you need help weighing your options, it’s always a good idea to connect with your financial advisor or tax consultant. At NSO & Company, we’re always just a phone call away: (317) 588-3131. Please don’t ever hesitate to reach out!