Wash Sales - Quickfinder 7-6
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:
- Buy substantially identical stock or securities,
- Acquire substantially identical stock or securities in a fully taxable trade,
- Acquire a contract or option to buy substantially identical stock or securities, or
- Acquire substantially identical stock for your individual retirement account (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.
What is the wash sale rule and how does it work?
A wash sale is when an investment is sold at a loss and the same or a "substantially identical" investment is purchased either 30 calendar days before or after the sale. If that happens, a wash sale has occurred.
Publication 550 / Page 58
When does a wash sale occur?
- 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 account (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.
What happens to the disallowed loss in a wash sale?
If your loss was disallowed because of the wash sale rules, add the disallowed loss to the cost of the new stock or securities (except in (4) above). The result is your basis in the new stock or securities. This adjustment postpones the loss deduction until the disposition of the new stock or securities. Your holding period for the new stock or securities includes the holding period of the stock or securities sold. Example 1. You buy 100 shares of X stock for $1,000. You sell these shares for $750 and within 30 days from the sale you buy 100 shares of the same stock for $800. Because you bought substantially identical stock, you cannot deduct your loss of $250 on the sale. However, you add the disallowed loss of $250 to the cost of the new stock, $800, to obtain your basis in the new stock, which is $1,050.
What happens when the wash sale rule has been violated?
How can I trade without violating the wash sale rule?
In general, wash sales are best avoided whenever possible to preserve the tax benefit of the capital loss. They can be avoided by simply waiting until the 61-day wash sale period is over before repurchasing exactly the same investment. If you want to stay invested in a similarly-performing investment, you can purchase securities that are similar but not substantially identical to the investment you sold off.
Can the wash sale rules be avoided if I sell stock at a loss in my taxable account and buy it back the next day in my IRA?
No basis adjustment in IRA - a loss is a loss forever.
This was further clarified by the IRS in Revenue ruling 2008-5. In that ruling the IRS stated: “The loss on the sale of the stock or securities is disallowed under section 1091 of the Code, and the individual’s basis in the IRA or Roth IRA is not increased by virtue of section 1091(d).
If you sell a put within 30 days of realizing a loss on the sale of a stock, do you create a wash sale?
Yes.
Wash Sale Rules When Short Selling Stocks
The IRS wash sale rule is a bit different when it comes to short selling stocks (sell stock short or short sales). IRS publication 550 page 56 states:
Short sales. The wash sale rules apply to a loss realized on a short sale if you sell, or enter into another short sale of, substantially identical stock or securities within a period beginning 30 days before the date the short sale is complete and ending 30 days after that date.
Therefore, if you cover, or buy back, your short sale shares at a loss and then sell short the same stock again within the 30 day period, you have a wash sale, and the loss becomes part of your future cost basis when you finally cover the short. This is a bit different in the sense that a sale has triggered the wash sale rather than a purchase.
Warning: Some broker 1099-Bs adjust the sales amount rather than the cost basis resulting in a real mess when trying to reconcile cost basis. See: Broker 1099-B Reporting Problems.
Can you purchase a call option on stock that you have sold within the 30-day wash sale period?
No, it’s the same security. Pub 550. Page 58
Can you sell a call option within 30 days of realizing a loss on the sale of a stock without creating a wash sale?
Will I have any wash sale implications if I sell a stock or security for a gain and buy back the same stock or security within 30 days?
What is considered “substantially identical” property?
- ►In determining whether stock or securities are substantially identical, you must consider all the facts and circumstances in your particular case.
- ►Ordinarily, stocks or securities of one corporation are not considered substantially identical to stocks or securities of another corporation.
- ►Bonds or preferred stock of a corporation are not ordinarily considered substantially identical to the common stock of the same corporation. However, where the bonds or preferred stock are convertible into common stock of the same corporation, the relative values, price changes, and other circumstances may make these bonds or preferred stock and the common stock substantially identical
If I sell an S&P 500 Index mutual fund from one fund company at a loss, and buy an S&P 500 Index mutual fund from a different fund company within 30 days, will I have a wash sale?
- ►Does the wash sale rule apply to options, ETFs and mutual funds?
Yes. Keep in mind that if the security has a CUSIP number, then it's subject to wash-sale rule reporting. Switching from one ETF to the identical index in another fund or ETF could trigger the wash-sale rule.
- ►What’s exempt from wash sale losses?
Wash sales do not apply to Section 1256 contracts including futures, broad-based indices, and options on futures since they are marked-to-market (MTM) (40 short/60 long split).
- ►Can DRIP (Dividend reinvestment Programs) programs cause a Wash Sale?
Yes.
Example: Larry Laundry buys 500 shares of XYZ Corp. for $10,000 and sells them on June 5 for $3,000. On June 30, he buys 500 shares of XYZ for $3,200. Since the stock was repurchased within 30 days of loss-sale date, the wash-sale rules apply. Larry can't claim his $7,000 loss. Instead, he must adjust his basis in the repurchased shares. His basis in his new 500 shares is $10,200 -- the actual cost plus the $7,000 disallowed loss.
Larry would also be in violation of the wash-sale rules if he purchased his new shares on June 1 and then made the loss sale on June 5. Remember, the rule is 30 days before or after the date of the loss sale. But also remember that if Larry had waited for the required 30 days before he purchased another 500 shares, there would be no wash sale.
Buying fewer shares
What if you repurchase fewer shares than you originally sold for a loss? Is all of the loss disallowed? Nope. Only the portion of the loss attributable to the "washed" shares will be disallowed.
Thus, in the above example, if Larry had bought back only 300 of the 500 shares (60%), he would be able to claim 40% of the loss on the sale ($2,800). The remaining $4,200 of the loss disallowed under the wash-sale rules would be added to Larry's cost of the 300 shares, and Larry's basis in the new shares would be $6,120 -- the cost of the original 300 shares of $1,920 plus the disallowed loss of $4,200.
- Reporting -
Reporting Wash Sales on Form 8949
All investment sales are reported on Form 8949 then summarized on Schedule D.
The IRS requires that the transaction is identified with code "W" in column (b), and the loss adjustment must be reported in column (g) when a particular sales transaction is a wash sale. Wash sale adjustments were reported on a second line immediately underneath the sale to show the adjustment before 2011.
Adjusting the Cost Basis
By adding the wash sale loss to the cost basis of the replacement shares, the loss is deferred and can be recouped when the replacement shares are sold. The IRS advises, "If your loss was disallowed because of the wash sale rules, add the disallowed loss to the cost of the new stock or securities. The result is your basis in the new stock or securities. This adjustment postpones the loss deduction until the disposition of the new stock or securities. Your holding period for the new stock or securities includes the holding period of the stock or securities sold."
Go to the IRS website and download Schedule D and Form 8949. Starting with Form 8949, enter your name and Social Security number at the top of the form. On the line below, check the appropriate box as to whether the transaction was reported to the IRS with or without the basis.
Move down to Part 1 -- Short-Term Capital Gaines and Losses -- on Form 8949. Enter a description of the property and the number of shares purchased. For example, you might say "100 shares of ABC stock." Enter “W” in column B to denote it as a wash sale. In column C, use the information on your brokerage statement to enter the month, day and year you purchased the investment. In column D, enter the month, day and year you sold it. In column E, enter the sales price. In column F, enter the cost or other basis of the property.
Enter the total amount of columns D and E on line 2 at the bottom of the page. Transfer this information to Schedule D. Be sure the line you select on Schedule D corresponds to the box you checked on Schedule 8949. Enter the information on the appropriate line, and on Line 7, column H, as a negative. File Schedule D and Form 8949 along with your completed 1040.
Items you will need
- Schedule D, Capital Gaines and Losses
- Form 8949, Sales and Other Dispositions of Capital Assets
- Brokerage statement
Tip
- Review all your brokerage statements carefully to be sure you don't overlook a wash transaction.
Warning
- Although you cannot deduct a wash sale loss, you must report any gains you made on the trade.