More Wash-Sale Matters for the Tax Nerds

And if you haven't guessed by now, the Internal Revenue Service really wants to prevent taxpayers from entering into transactions designed just to create a tax break and immediately reconstructing their previous position. And that includes all classes of taxpayer -- including corporations. The wash-sale rule even applies to an oral sale-and-repurchase agreement between business associates. The only taxpayers not subject to the rule are securities dealers incurring losses in the course of their business.

So now let's move into the arcane areas that you keep sending questions about. I answer some reader questions here, but for more information you can also see Tax Time -- Who Needs to Worry About the Wash-Sale Rule?, Don't Get Crafty With the Wash-Sale Rule and Swapping That ETF Might Not Trigger a Tax Hit.

Dear Beverly,

Your warning that buying securities in an IRA after selling identical securities for a loss in a non-IRA account would be considered a wash sale brings up another wash-sale question that's always nagged me.

I own a bond fund in a non-IRA account. Dividends are automatically reinvested every month. Thus, whenever I redeem any shares for a loss, I always automatically repurchase a small amount within a month via the dividend reinvestment. Does this fall under the wash-sale rules?

In other words, if I sell 1,000 shares at a loss, then five days later buy back 10 shares via the dividend reinvestment, can I only claim the loss on 990 of the 1,000 shares? Surely my intent here is not to create the kind of loss that wash-sale rules are intended to prohibit.

Thanks.

Sincerely,
Geoff B.

Sorry, Geoff, but in this instance the IRS doesn't care much about intent. If you redeem fund shares at a loss within 30 days before or after a dividend distribution is reinvested into your account, a wash sale results, and the portion of the loss allocable to the reinvestment is not deductible. As noted earlier, the disallowed loss is actually deferred, as it is added to the cost basis of the replacement shares and will affect the computation of gain or loss on a later sale.

So in your case, you're correct in that you'd only be able to claim a loss on 990 of the 1,000 shares you sold. But let's say you have a $25 loss on each of those shares. That $25-per-share disallowed loss will be added to your basis in the 10 new shares purchased via your automatic dividend reinvestment plan. Since your basis will be $25 higher than what you actually paid, you'll still get a tax break -- just not immediately. Rather, when you sell those shares, either your gain will be lower (meaning lower capital gains tax) or your loss will be greater (meaning a larger deduction). So while this may be small consolation, know that the loss is still there, in your portfolio -- it's just not on your 1040. Yet.