Wash sale rules are designed to prevent you from taking “too much” advantage of temporary dips in the stock market to generate capital losses that you can deduct on your income tax return. Essentially, they are designed to keep you from selling at a low price to realize a loss and then buying the same security right away.
The rules for wash sales are tricky. Put as simply as possible, if you sell a security at a loss, then if you buy “substantially identical” securities within 30 days before or after the loss-generating sale, then wash sale rules come into effect. And you can’t get around this by having your spouse buying the security back instead!
Having a trusted financial advisor who considers many facets of your investments before making recommendations is a way to avoid problems that you could create for yourself.
Here’s what IRS Publication 550 says:
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 arrangement (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.
There are several concepts to address, but let’s start with an example of a wash sale.
Wash Sale Example
Let’s say you sold 100 shares of an ETF at $1.00 per share on April 1. You originally paid $1.25 per share, so you have a loss of $25. You then buy 100 shares of the same ETF at $1.10 per share on April 15. Because you bought the same ETF again within 30 days of the sale, this means the sale on April 1 is a wash sale.
For income tax, purposes you will not be allowed to recognize $25 loss (100 shares x ($1.00/share purchase price – $0.50/share sale price) on the sale. All you are allowed to do is add the non-allowed loss of $25 to your basis in the shares you purchased on April 15, so your tax cost basis for those shares is $1,125 instead of $1,100. You will you use this adjusted basis to figure your gain or loss when you sell the second tranche of shares in the future.
Wash Sale Rules Are Tricky
This is a simple example, but it can get tricky very fast.
- What if you don’t always buy and sell the same number of shares? For example, maybe you sell 75 shares and then buy 125 shares that triggers a wash sale. You still have to treat the 75 shares sold as a wash sale.
- What if you sell shares in your taxable account and buy the same shares in your IRA? Even though the transactions are in different accounts, you still have a wash sale.
- What if you sell shares in your taxable account and your spouse buys them in another taxable account? Yep, that’s a wash sale.
Keeping Track of Wash Sales
Luckily, your brokerage account must track wash sales. However, each account tracks wash sales only within that account. If you have investing activity in multiple accounts that triggers wash sales, you need to track those carefully. This is where a competent financial advisor who has a holistic view of your financial life can be invaluable.
At Dominion Financial Advisors, we strive to provide excellent service without overcharging for it. Monitoring and managing wash sales is just one example of this. Schedule a consultation or contact us to find out how we can help you with financial planning and wealth management.