You may be considering booking stock losses due to recent market drops. Selling can be a great strategy when these losses can offset other gains and up to $3,000 of your ordinary income. However, a little-known rule called the wash sale rule could surprise the unwary taxpayer. Sometimes, understanding tax terms is difficult. We make it easy.  So, what is a wash sale anyway?

Understanding tax terms

If the wash sale rule applies to your transaction, you cannot immediately report a loss you take when selling a security. Per the IRS:

“A wash sale occurs when you sell or trade stock or securities at a loss, and within 30 days before or after the sale, you:

• Buy substantially identical stock or securities,
• Acquire substantially identical stock or securities in a fully taxable trade,
• Acquire a contract or option to buy substantially identical stock or securities, or
• Acquire substantially identical stock for your retirement account (IRA) or Roth IRA.”

Why wash sales?

Many investors were selling stock; they liked to book the loss for tax reasons. They then turned around and immediately re-purchased shares of the same company or mutual fund. If done repeatedly, shareholders could constantly be booking short-term losses on a desired company while still indefinitely owning the shares in that company’s stock. Clever shareholders would even purchase the replacement shares before selling other shares in the same company to book the loss.

How to take advantage

How does one take action to ensure the wash sales rule works to your advantage?

1. Check the dates. If you decide to sell stock to book a loss this year, ensure you haven’t inadvertently acquired the same company’s shares 30 days before or after the sale date.
2. Dividend reinvestment. If you automatically re-invest dividends, you will want to ensure this doesn’t inadvertently trigger the wash sales rule.
3. It’s only for losses. Remember, the wash sales rule only applies to investments sold at a loss. It does not apply if you are selling stock to capture gains.
4. Consider similar transactions. The wash sales rule applies to buying and selling ownership in the same company or mutual fund. Except for some common versus preferred stock of the same company, buying and selling similar, but not identical, shares does not apply to the wash sales rule.

If your loss is ever disallowed because of the wash sales rule, you can add the disallowed loss to the cost of the new security. When the security is eventually sold, the previously forfeited loss will be part of calculating future gain or loss. This also includes the original stock’s holding period to help define the transaction as a short-term or long-term sale.

Please contact our RRBB advisors if you have any questions.