What a bunch of tax nerds you all are.
There's been a remarkable bit of reader interest in various aspects of the wash-sale rule, so let's address the basics first, and then I'll answer a few reader questions.
The wash-sale rule prevents taxpayers from claiming a loss on securities if the exact same ("substantially identical" in tax parlance) securities are purchased within 30 days of the sale -- either before or after the sale, making it a 61-day period. In other words, if you sell 100 shares of
at a loss on March 30, but also buy 100 shares either 30 days before the sale or within 30 days after, the Internal Revenue Service won't allow you to claim the loss on that sale. The loss is really disallowed only temporarily -- the basis of the new shares is adjusted to reflect the money lost in the sale, so the loss is accounted for when the new shares are sold.
Put and call options are also covered under the wash-sale rule, so you won't be able to claim a loss on securities you've hedged with options within 30 days (on either side) of the sale.
The same goes for shares in a mutual fund -- if you incur a loss when redeeming shares, but also purchase new shares in the same fund within 30 days of the redemption, the loss will be disallowed. And yes, that includes reinvested dividends. If the distribution is reinvested, you're technically purchasing more shares, even if it's a part of an automatic program. The allocable loss is disallowed, even though the wash-sale rule was inadvertently triggered. As with stocks, the disallowed loss on fund shares is added to the cost basis of the replacement shares and will affect the computation of the gain or loss when those shares are eventually sold.
And if you haven't guessed by now, the Internal Revenue Service
wants to prevent taxpayers from entering into transactions designed just to create a tax break and immediately reconstructing their previous position. And that includes
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.
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.
Beverly, What happens if you have a wash sale (sell stocks at a loss but repurchase within the taboo 61-day period), but you don't hold any of your stocks for longer than a month? Specifically, what happens to the basis adjustment in the repurchased shares if they, too, are sold within 30 days?Thanks for your help!Alan A.
Well, Alan, the short answer is that it all comes out in the wash. When you repurchase shares in a wash sale, the basis gets adjusted upward by the amount of the disallowed loss. Whenever you sell those shares, you'll get the delayed tax benefit -- in the form of either owing less in capital gains tax (if the shares appreciated) or a greater loss. (Even if the shares remained the same price as when you purchased them, you'd still be able to claim a loss, since your basis was inflated by the loss from your previous position.)
It doesn't matter when you sell those repurchased shares. You'll get a tax break whenever you do ... provided, of course, that you don't
run afoul of the wash-sale rule. If you do, simply adjust the basis in those shares and delay the tax break once more. Once you've closed out of a position entirely for 30 days, you'll be able to take advantage of the tax break inherent in the new basis of the last shares to be sold.
So no matter how many times you've run afoul of the wash-sale rule in a given tax year, if you're completely closed out of the position 30 days before the end of the year, you're allowed to claim the loss.
Is there a "reverse" wash rule?For instance, I had a stop loss in while I was on vacation, which triggered. I got home and decided that I really liked the stock, and bought it back, about two weeks after the stop loss triggered, for less than the stop-loss sale. Now, can I just use the profit from the sale and re-buy to lower my basis, or do I have to report the profit on the IRS schedule D?Giles G.
The wash-sale rule applies only to the deductibility of losses --
the taxability of gains. It sounds like when the stop loss (a customer order to a broker to sell the security once its price drops to a certain level below its current trading price) was triggered, you sold the stock at a profit. The stock price continued to fall, and you repurchased the shares at a lower price.
If this is the case, you
avoid paying tax on the gain by adding it to the lower basis in your new shares; you must report the profit to the IRS on Schedule D of your 1040. Sorry.
If someone sells a stock in a brokerage account and then buys it back 25 days later in an IRA account, how would the IRS ever learn of the buyback since there are no 1099s issued for stock transactions within IRAs? Scott A.
Well, Scott, I'm sure you're speaking hypothetically, but let me be blunt: It's your responsibility to tell the IRS. To not do so would be cheating, and if the IRS audited you for any reason and learned of the deception, you could owe back taxes, interest and -- depending on how egregious the error and its suspected motivation -- possible criminal charges.
"Just because an institution isn't required to send you and the IRS a 1099 doesn't mean you don't have to report the transaction," says Davis, Calif., CPA Mark Castellucci. "It's up to you to file your taxes correctly."
And that means properly reporting such transactions on Schedule D of your 1040. In the instructions to the Schedule D (you can find both the form and its instruction booklet at the
IRS Web site) there's a worksheet to help you figure how to report a loss from a sale. Included on that worksheet is a line for a wash-sale disallowance, which then adjusts the allowable loss -- and that's the figure that gets transferred to the Schedule D.
Now, realistically, it's pretty uncommon for the IRS to audit a taxpayer so thoroughly that they request the trading records of a taxpayer's IRA. But if they
become aware of the situation, well, let's just say that would be just the beginning of a whole series of problems. If you have any more questions in that vein, you're probably better off asking a tax lawyer.