Yesterday, I talked about selling losing stocks so we can realize a capital loss to reduce taxes. However, we cannot just sell the stocks and buy them back just to get the tax benefits because it will violate the wash sale rule. This rule prevents us from taking a tax loss on a security sale if we bought the same or substantially identical stock 30 days before or 30 days after the sale.
If you do end up buying the stock back within 30 days however, the loss can be applied to the cost basis of the purchase. Let me illustrate.
Remember the ETrade (ETFC) that I mentioned about yesterday? Let’s say I sold all my shares at $4 per share after reading the article from this blog for a loss of $12,000 and I bought 1000 shares back at $3.80 today. The wash rule disallows me to take the original $12,000 tax loss but I can add the original $12,000 loss to my new cost basis, making the final cost basis of $15,800.
In my example, I have used the same stock. However, buying any substantially identical security within 30 days also violates this rule. Since there’s no clear cut definition of what IRS considers identical, it could get confusing. For example, funds can run into problems because they can both invest in the same sector of stocks. I read a bunch of articles and the consensus seems to be that funds from a different fund group investing in the same sector are generally not considered substantially identical but two funds from the same fund group investing in the same sector might be considered the substantially identical.
All I can say is that we should only sell securities because there is no point to hanging on to it anymore. If the IRS does an audit and they think that the sale is purely based on tax reasons, they will disallow it.
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{ 4 comments… read them below or add one }
This is great information. Many people don’t understand how the wash rule works or the basic premise of tax loss selling.
Thanks for your insight.
Not everyone remembers the wash sale rules as they do year-end tax planning. thanks for reminding us all.
Best Wishes,
D4L
Thanks for the info. It is the rule of the market nowadays in trading
David,
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