Investors who own stocks or other securities that have decreased in value frequently sell them in order to benefit from the losses for tax purposes. It’s not a bad idea, especially if it’s a stock you want to sell anyhow; you may use the loss to reduce capital gains or, to a lesser extent, reduce other kinds of taxable income like regular income.
But what if you still like the stock and don’t really want to sell it? Why not simply sell it, pocket the loss, and then purchase it again right away? Simply put, no. The wash-sale rule was created specifically to stop people from taking advantage of tax losses on investments they don’t intend to sell.
What Is A Wash Sale?
A wash sale, as defined by the wash-sale regulations, occurs when you sell a stock or security for a loss and either buy it back within 30 days of the loss-sale date or “pre-rebuy” shares within 30 days of selling your longer-held shares.
As a result of the sale and subsequent (or earlier) acquisition “washing out” one another, the loss is not deemed recognized for tax purposes in either scenario. This regulation is intended to stop people from selling stock solely to take advantage of the tax break without planning to exit the investment.
In order to prevent you from purchasing the stock “back” before it has even been sold, the restriction is again applicable for a 30-day window before and after the selling date.
Examples of wash-sale rules
Consider selling 100 shares of XYZ Corp. for $3,000 on June 1st with a cost basis (the price you paid) of $10,000. That amounts to a $7,000 loss, which you can deduct from your taxes if you own the shares in a taxable brokerage account.
However, if you were to repurchase shares at any point between June 2 and July 1, the sale would be regarded as a wash sale, and the loss would not be deductible as a business expense. The same rules apply if you purchase shares within 30 days of your sale; in this case, if you did so anytime on or after May 2, you would “wash out” your taxable loss by purchasing shares equal to those you sold on June 1.
When you purchase less shares, what happens?
The fact that wash sales come out to 1:1 for each share you repurchase is an important aspect of them. Using the aforementioned example, the taxable loss on 50 shares would be eliminated if you made a repurchase during the 30-before-to-30-after period.
Rules for wash-sale
Let’s sum everything up: A wash sale can also involve buying stock options, so it’s not only about buying equities in this case. Additionally, if you purchase identical shares in a different account, such as a regular or Roth IRA, the restriction still applies. In other words, even if you buy shares during the timeframe that results in a wash sale, you cannot harvest a tax loss in your taxable account (including retirement accounts).
One more point: Wash-sale laws apply to shares sold at a loss, but there are no equivalent wash-sale regulations for shares sold at a profit. In other words, even if you sell stock at a profit and immediately buy it back, you still need to declare the entire gain.
How may a wash sale be avoided?
Avoiding purchasing shares of the same stock within 30 days of selling or within 30 days of buying is the first and most obvious thing to do. If you do, you will not be able to claim a tax loss on the quantity of shares you buy.
However, if you unintentionally turn a wash sale into a replacement purchase by repurchasing too quickly, your prospective taxable loss doesn’t simply vanish into thin air: The “lost” tax basis transfers to the replacement purchase. Simply conduct another sale while according to the wash-sale guidelines. Finally, you’ll be able to recoup the tax loss.
