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A Message from Kimberly Clouse, Financial Expert:
I have worked in the financial services industry for
nearly a decade in many capacities, most recently as
a financial advisor for individuals. Over the course
of my career, I have had the privilege of working with
a diverse range of people, from the single mother just
starting her own business to the dot.com billionaire.
Based upon my experiences, I have learned that the same
basic principles and lessons apply to a successful and
healthy financial life, whether you're starting out
or cashing out. These guiding principles include simplicity,
a long-term perspective, and above all, knowing that
you have control of your financial destiny, and all
the information you need is well within your reach.
What is the Wash-Sale Rule?
Consider this scenario: On October 31st, you sell 100 shares
of Acme Halloween Company at a loss. On November 10th, a television
report claims that Halloween decorations will be all the rage
this Thanksgiving, and you buy 100 shares of Acme Halloween
on November 11th. Enter the wash-sale rule. If you sell Acme
shares on October 31st, and buy them back within 30 days,
the Internal Revenue Service (IRS) will not allow you to deduct
the loss on your tax return. Since the IRS allows taxpayers
to use losses to offset unlimited capital gains and up to
$3,000 of other income, it is certainly worthwhile to consider
selling losing stocks from a tax perspective, but be mindful
of the restrictions.
A wash sale is defined as the purchase and sale of a security
either simultaneously or within a short period of time. Wash
sales taking place within 30 days of the underlying purchase
do not qualify as tax losses under the IRS rules. The wash-sale
rule prohibits investors from selling a security to create
a loss and then quickly repurchasing substantially identical
securities within 30 days before or after the sale. Therefore
the wash-sale period for any sale at a loss consists of 61
calendar days: the 30 days before the sale, the sale date,
and the 30 days after the sale. In the above example, for
an October 31st sale, the wash-sale period includes all of
October and November, and, consequently, the October 31st
sale would be deemed a wash sale. If you waited until December
1st to buy the replacement Acme Halloween shares, you would
no longer fall in the wash-sale period and could have taken
the tax loss for the October 31st transaction.
The definition of “substantially identical securities”
is not hard and fast, but the underlying concept is that risk
and wash sales are inextricably linked. If you are able to
create a strategy that totally eliminates the potential downside
from your sale and repurchase transactions, then you will
likely have a wash sale. In general, the stocks of two companies
in the steel industry are not considered to be substantially
identical; however, if the price performance of these two
stocks were linked in some way, then you would probably fall
into wash-sale territory. Since the rule applies to “securities,”
wash-sale situations can occur even if you do not acquire
stock but instead enter into an option contract to purchase
replacement shares. (An option is the right to buy or sell
property that is granted in exchange for an agreed upon sum.)
Accordingly, you can trigger a wash sale from selling options
at a loss.
The wash-sale rule is particularly important as you plan
for taxes generated from your investment portfolio. But the
wash-sale rule applies only to losses, and you cannot eliminate
a gain from a sale by buying the same stock back within 30
days. Of course, taxes should never be the primary reason
behind investment decisions, so always consider the long-term
value of the stock and weigh that against the benefit you
will receive by claiming a deduction for the loss. If you
do find yourself in a wash-sale situation, consult your accountant
or financial advisor, as the consequences of the wash-sale
rule can also impact the basis (typically the purchase price
of the shares) and holding period of the replacement stock.
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This column is designed to provide accurate and authoritative
information on the subject of personal finances. It is provided with the understanding
that the Author is not engaged in rendering legal, accounting, or other professional
services by publishing this column. As each individual situation is unique,
questions relevant to personal finances and specific to the individual should
be addressed to an appropriate professional to ensure that the situation has
been evaluated carefully and appropriately. The Author specifically disclaims
any liability, loss or risk which is incurred as a consequence, directly or
indirectly, of the use and application of any of the contents of this work.
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