A wash sale occurs when you sell a security at a loss but then repurchase it within 30 days at the low price.The subsequent purchase could occur before or after the security is sold, creating a 61-day window that must be monitored to identify wash sales.

IRS Explanation of Wash Sales

Wash Sale Example

How to determine Substantially Identical?

What the Wash Sale Rule Really Means to Investors

 

IRS Explanation of Wash Sales

wash sale occurs when you sell or otherwise dispose of stock or securities (including a contract or option to acquire or sell stock or securities) at a loss and, within 30 days before or after the sale or disposition, you:

  • Buy substantially identical stock or securities,
  • Acquire substantially identical stock or securities in a fully taxable trade,
  • Enter into a contract or option to acquire substantially identical stock or securities, or
  • Acquire substantially identical stock or securities for your individual retirement arrangement (IRA) or Roth IRA.

You cannot deduct losses from wash sales unless the loss was incurred in the ordinary course of your business as a dealer in stock or securities. The basis of the substantially identical property (or contract or option to acquire such property) is its cost increased by the disallowed loss (except in the case of (4) above). For more details on wash sales, see Pub. 550.

Report a wash sale transaction on line 1 or 8. Enter the full amount of the (loss) in column (f). Directly below the line on which you reported the loss, enter “Wash Sale” in column (a), and enter as a positive amount in column (f) the amount of the loss not allowed.

 

Wash Sale Example

Example 1.

You buy 100 shares of XYZ 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.

 

Example 2.

You are an employee of a corporation that has an incentive pay plan. Under this plan, you are given 10 shares of the corporation’s stock as a bonus award. You include the fair market value of the stock in your gross income as additional pay. You later sell these shares at a loss. If you receive another bonus award of substantially identical stock within 30 days of the sale, you cannot deduct your loss on the sale.

 

How to determine Subtantially Identical?

 

when 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. However, they may be substantially identical in some cases. For example, in a reorganization, the stocks and securities of the predecessor and successor corporations may be substantially identical.

Similarly, 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. For example, preferred stock is substantially identical to the common stock if the preferred stock:

  • Is convertible into common stock,
  • Has the same voting rights as the common stock,
  • Is subject to the same dividend restrictions,
  • Trades at prices that do not vary significantly from the conversion ratio, and
  • Is unrestricted as to convertibility.

 

What the Wash Sale Rule Really Means to Investors

 

If you are an active trader in a particular stock, it is very necessary for you to track your trades and monitor your wash sales period before you re-purchase the same stock. If you suffered a loss, and you need to pay attention to the date you repurchase the substantially identical secuirty and still claim the earlier loss on taxes.

Manually tracking and figuring out the wash sale is really a time-consuming job for investors, but using a produce such as TradeMax can help manage your wash sale well, and avoid re-buying the same stock in wash-sale period.

While you will eventually realize losses deferred by wash sales, avoiding them in the first place will help you maximize your investment performance.