Why You Should Consider The Wash-Sale Rule Before Buying And Selling Stocks

When you are buying and selling stocks throughout the year, one issue you need to consider is a wash-sale. The wash-sale rule refers to selling an investment you held at a loss and then buying it back in the 30 day period before or after your original sale date. A gain you realize when you sell an asset for more than you purchased it for is taxable as a capital gain. Similarly, if you sell the investment at a loss, you can claim this loss against other capital gains you secure during the year.

When your capital losses are greater than your capital gains in a year, you are able to deduct as much as $3,000 of the losses against your taxable income. Any excess loss you have over the $3,000 limit carries forward into future years. This rule applies to most investments you would have in an investment account, such as stocks, exchange traded funds (ETFs), mutual funds, bonds, and options.

There are certain rules that apply to taking these capital losses. You are not able to skirt the wash-sale rule by liquidating a holding in a taxable account and then re-purchasing it with a tax-advantaged account. The IRS also states that if a spouse sells an investment for a loss and then the other spouse buys it back within the 30-day time period this is considered a wash-sale.

An example involves shares of a common stock. If you bought 100 shares of XYZ Computers at $100 a share and the price declines to $50 a share, you might sell it on January 5 to take the $5,000 loss. You could then apply this $5,000 loss to lower other capital gains for the year. Any excess losses remaining, up to $3,000, you could apply as a write off against your other taxable income. One notable exception is that you can no longer deduct losses from a Roth IRA. Consider that the XYZ Computers stock further declines to $35 a share on January 28. You might decide to repurchase your shares. This transaction involving the XYZ Computer stock would now qualify as a wash-sale because you bought the stock back 23 days later. Now you would not be able to write off the $5,000 loss.

Your loss that was not allowed would be added to the cost basis of $85 a share (a combination of the $50 share loss realized in the original sale added to the $35 price when you repurchased them on January 28). As this wash-sale time frame runs for 30 days before a sale to 30 days following one, you are not able to purchase the "substantially identical" holding in the 61 day window.

It is a common practice for investors to look for tax loss harvesting. This simply refers to intentionally selling positions you are holding for a loss in order to gain the tax benefits accrued in realizing such losses. Many people consider tax loss harvesting around the end of a year, but it is smarter to contemplate it all year long. This practice can help you avoid the problems with the wash-sale rule.

A final wash-sale rule danger to consider is if you have multiple investment accounts where a professional money manager handles one of them on your behalf. When you liquidate a stock in an account you personally manage and your money manager purchases that same stock in the wash-sale period, it still qualifies as a wash-sale. It does not matter that you did not order the specific purchase personally. Remember that both realized and unrealized capital gains can affect you.