Taxes From A To Z (2017): W Is For Wash Sale

It’s my annual “Taxes from A to Z” series! If you’re wondering whether you can claim wardrobe expenses or whether to deduct a capital loss, you won’t want to miss it.

W is for Wash Sale.

Typically, if your losses equal your gains, you call it a wash. For tax purposes, however, 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,
Acquire substantially identical stock in a fully taxable trade,
Acquire a contract or option to buy substantially identical stock, or
Acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA.

A substantially identical stock or (security) is exactly what it sounds like. You can end up with a wash sale when you sell shares of a stock and then buy the same stock. You can also end up with a wash sale if you sell shares of a stock and buy shares of stocks of a related company, including predecessor or successor companies in a reorganization. The Internal Revenue Service (IRS) considers facts and circumstances when determining whether a stock (or security) is “substantially identical.”

Most taxpayers can’t deduct losses from sales or trades of stock in a wash sale (there’s an exception if the loss was incurred in the ordinary course of your business as a dealer in stock or securities).

If your loss was disallowed because of the wash sale rules, add the disallowed loss to the cost of the new stock: the result is your basis. What this does, basically, is defer the loss until you get rid of the new stock. Your holding period for the new stock includes the holding period of the stock that you sold at a loss.

Here’s an example:

1, You buy 10 shares of stock for $10 each, or $100 total.
2, You sell them at a loss for $6 each, or $60 total.
3, The next week, you buy 10 shares of the same stock for $7 each, or $70 total.

If you had bought shares of a different stock the next week, you would have had a loss of $40 ($100 basis less $6 selling price = $40 loss). However, because these shares were the same, you’re subject to the wash sale rules and you may not claim the loss.

But let’s say that a year later, you sell the stock for $200. Since you bought the shares for $70, you might be inclined to think your gain is $130. But your gain is $90 – not $130 – because you must add the previously disallowed loss to the purchase price to determine your basis. In other words, your gain is figured by taking the $200 selling price and subtracting your adjusted basis ($110, or $70 purchase price + $40 disallowed loss from before). Got it?

If you buy or sell an unequal number of substantially identical shares of stock, pay attention to the ordering. For purposes of the wash sale rules – and adjusting your basis – you must match the shares bought with an equal number of the shares sold in the same order that you bought them, beginning with the first shares bought. In other words, if you buy shares at different times, you must keep good records so that you can match them up for purposes of applying the rules.

The wash sale rules apply not only to stocks but to losses from sales or trades of contracts and options to acquire or sell stock or securities. They do not, however, apply to losses from sales or trades of commodity futures contracts or foreign currencies.

You’ll report a wash sale using form 8949, Sales and Other Dispositions of Capital Assets (downloads as a PDF). The code for a wash sale is “W” and you’ll put that in column (f).

While the rules appear straightforward, buying and selling certain stocks, especially as they apply to short sales and certain securities, can be complicated. If you have questions, check with your tax professional.

For more Taxes A to Z, check out: