Disclaimer and Warning - From Bob Parrish CPA, P.C.
Remember........"You can have everything in life you want, if you just help enough other people get what they want." -Zig Ziglar.
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You cannot currently deduct (i.e., the losses are suspended) losses from sales or trades of stock or securities in a wash sale, until the stock or security replacing the shares sold are themselves sold. Generally no gain or loss from the daily fluctuation of the market price on a security is included on the tax return. The fluctuation in market prices is included only when the owner sells the security. The reasoning of the wash sale rule is to inhibit taxpayers from selling a security with a loss and then immediately repurchasing the same security - merely to claim a loss. With this insight, then one should understand the wash sale rule process is to merely suspend the loss on reacquired securities until the securities are actually fully removed from the portfolio. In order to know whether you are subject to this rule you must know the following:
All transactions within the wash sale look-back and look-forward period
The tax and cost basis of all the securities (the method of acquiring the securities will affect this)
The time period you have held the shares
Broker statements and all relative 1099 forms
Stock or mutual fund ledger - used in conjunction with the broker statement and 1099 forms to determine the quantity of shares you own and relate the buys and sells to the wash sale rules (see for example: If the number of shares sold is not the same as the number repurchased; The stock was part of an incentive pay plan ) Hint: If the broker statements or your securities ledgers show no balance of shares at the end of the year, then you have answered the question about any "wash sale" issues in the 30 days prior to the sale - you should then inspect the quantities and balances for the 30 day period subsequent to the sale trade date for transactions relevant to the wash sale rules -- even if it is subsequent to the end of the tax year.
Other information may be required for completing the tax return - however those items are not covered in this topic
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, or
Acquire a contract or option to buy substantially identical stock or securities.
Mutual funds can distribute dividends and reinvest them as often as monthly. Because of automatic reinvestment, it is possible that a sale of fund shares at a loss can result in an unintended wash sale. In addition most mutual funds offer automatic investment plans or investors use dollar cost averaging which, with either method, will usually result in an unintentional wash sale.
A wash sale is the sale (disposition) of a security at a loss and the acquisition of a substantially identical security within a period beginning 30 days before and ending 30 days after the date of sale. Losses resulting from wash sales are disallowed. Normally, investors are able to recognize the purchase of substantially identical stock within the 61-day period. However, with fund shares, taxpayers may not be aware that a purchase will occur within the 61-day period as a result of the automatic dividend reinvestment option.
Subsequent to a wash sale, the taxpayer must determine a new cost basis in the security purchased. For mutual fund shares the computation of the new cost basis can be complex, especially if the average cost method is used. Before selling any fund shares at a loss, investors who use automatic dividend reinvestment should check with the fund to determine whether a distribution has occurred or will occur within the 61-day period.
Many of the individuals now purchasing mutual fund shares are first-time equity investors, perhaps changing from certificates of deposit to mutual funds and unaware of the complex tax treatment they face. Tax advisors must be ready to help these new investors deal with the special tax problems associated with mutual fund investing.
If you sell stock and your spouse or a corporation you control buys substantially identical stock, you also have a wash sale.
If your loss was disallowed because of the wash sale rules, add the disallowed loss to the cost of the new stock or securities. The result is your basis in the new stock or securities. This adjustment postpones the loss deduction until the disposition of the new stock or securities. Your holding period for the new stock or securities begins on the same day as the holding period of the stock or securities sold.
Example 1. You buy 100 shares of X stock 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 ($250) to the cost of the new stock ($800) to obtain your basis of the new stock, which is $1,050.
Example 2 Employee of Corp. 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.
Options and futures contracts. The wash sale rules apply to losses from sales or trades of contracts and options to acquire or sell stock or securities. They do not apply to losses from sales or trades of commodity futures contracts and foreign currencies. See Coordination of Loss Deferral Rules and Wash Sale Rules under Straddles, later, for information about the tax treatment of losses on the disposition of positions in a straddle.
Warrants. The wash sale rules apply if you sell common stock at a loss and, at the same time, buy warrants for common stock of the same corporation. But if you sell warrants at a loss and, at the same time, buy common stock in the same corporation, the wash sale rules apply only if the warrants and stock are considered substantially identical, as discussed next.
Substantially identical. In 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.
More or less stock bought than sold. If the number of shares of substantially identical stock or securities you buy within 30 days before or after the sale is either more or less than the number of shares you sold, you must determine the particular shares to which the wash sale rules apply. You do this by matching the shares bought with an equal number of the shares sold. Match the shares bought in the same order that you bought them, beginning with the first shares bought. The shares or securities so matched are subject to the wash sale rules.
Example 1. You bought 100 shares of M stock on September 24, 1999, for $5,000. On December 21, 1999, you bought 50 shares of substantially identical stock for $2,750. On December 28, 1999, you bought 25 shares of substantially identical stock for $1,125. On January 4, 2000, you sold for $4,000 the 100 shares you bought in September. You have a $1,000 loss on the sale. However, because you bought 75 shares of substantially identical stock within 30 days of the sale, you cannot deduct the loss ($750) on 75 shares. You can deduct the loss ($250) on the other 25 shares. The basis of the 50 shares bought on December 21, 1999, is increased by two-thirds (50 ÷ 75) of the $750 disallowed loss. The new basis of those shares is $3,250 ($2,750 + $500). The basis of the 25 shares bought on December 28, 1999, is increased by the rest of the loss to $1,375 ($1,125 + $250).
Example 2. You bought 100 shares of M stock on September 24, 1999. On February 1, 2000, you sold those shares at a $1,000 loss. On each of the 4 days from February 15, 2000, to February 18, 2000, you bought 50 shares of substantially identical stock. You cannot deduct your $1,000 loss. You must add half the disallowed loss ($500) to the basis of the 50 shares bought on February 15. Add the other half ($500) to the basis of the shares bought on February 16.
Loss and gain on same day. Loss from a wash sale of one block of stock or securities cannot be used to reduce any gains on identical blocks sold the same day.
Example. During 1995, you bought 100 shares of X stock on each of three occasions. You paid $158 a share for the first block of 100 shares, $100 a share for the second block, and $95 a share for the third block. On December 23, 2000, you sold 300 shares of X stock for $125 a share. On January 6, 2001, you bought 250 shares of identical X stock. You cannot deduct the loss of $33 a share on the first block because within 30 days after the date of sale you bought 250 identical shares of X stock. In addition, you cannot reduce the gain realized on the sale of the second and third blocks of stock by this loss.
Dealers. The wash sale rules do not apply to a dealer in stock or securities if the loss is from a transaction made in the ordinary course of business.
Short sales. The wash sale rules apply to a loss realized on a short sale if you sell, or enter into another short sale of, substantially identical stock or securities within a period beginning 30 days before the date the short sale is complete and ending 30 days after that date.
For purposes of the wash sale rules, a short sale is considered complete on the date the short sale is entered into, if:
On that date, you own stock or securities identical to those sold short (or by that date you enter into a contract or option to acquire that stock or those securities), and
You later deliver the stock or securities to close the short sale.
Otherwise, a short sale is not considered complete until the property is delivered to close the sale.
Example. On June 2, you buy 100 shares of stock for $1,000. You sell short 100 shares of the stock for $750 on October 6. On October 7, you buy 100 shares of the same stock for $750. You close the short sale on November 17 by delivering the shares bought on June 2. You cannot deduct the $250 loss ($1,000 - $750) because the date of entering into the short sale (October 6) is considered the date the sale is complete for wash sale purposes and you bought substantially identical stock within 30 days from that date.
Residual Interests in a REMIC. The wash sale rules generally will apply to the sale of your residual interest in a real estate mortgage investment conduit (REMIC) if, during the period beginning 6 months before the sale of the interest and ending 6 months after that sale, you acquire any residual interest in any REMIC or any interest in a taxable mortgage pool that is comparable to a residual interest.
How to report. Report a wash sale or trade on line 1 or line 8 of Schedule D (Form 1040), whichever is appropriate. Show the full amount of the loss in parentheses in column (f). On the next line, enter "Wash Sale" in column (a) and the amount of the loss not allowed as a positive amount in column (f).
When you dispose of your mutual fund shares, you must determine your holding period. Your holding period determines whether the gain or loss is a short-term capital gain or loss or a long-term capital gain or loss.
Short-term gain or loss. If you hold the shares for one year or less, your gain or loss will be a short-term gain or loss.
Long-term gain or loss. If you hold the shares for more than one year, your gain or loss will be a long-term gain or loss.
Determining period held. Determine your holding period by using the trade dates of your purchases and your sales. The trade date is the date on which you contract to buy or sell shares. Most mutual funds will show the trade dates on confirmation statements showing your purchases and sales.
Do
not confuse the trade date with the settlement date, which is the
date by which the mutual fund shares must be delivered and payment must be
made.
To find out how long you have held your shares, begin counting on the day after the trade date on which you bought the shares. (Do not count the trade date itself.) The trade date on which you dispose of the shares is counted as part of your holding period.
Mutual fund shares received as a gift. If you receive a gift of mutual fund shares and your basis is determined by the donor's basis, your holding period is considered to have started on the same day that the donor's holding period started.
Inherited mutual fund shares. If you inherit mutual fund shares, you are considered to have held the shares for more than one year, regardless of how long you actually held them. Report the sale of inherited mutual fund shares on line 8 of Schedule D and enter "INHERITED" in column (b) instead of the date you acquired the shares.
Reinvested distributions. If your dividends and capital gain distributions are reinvested in new shares, the holding period of each new share begins the day after that share was purchased. Therefore, if you sell both the new shares and the original shares, you might have both short-term and long-term gains and losses.
Certain short-term losses. Special rules may apply if you have a short-term loss on the sale of shares on which you received an exempt-interest dividend or a capital gain distribution.
Exempt-interest dividends before short-term loss. If you received exempt-interest dividends on mutual fund shares that you held for 6 months or less and sold at a loss, you may claim only the part of the loss that is more than the exempt-interest dividends. On Schedule D, column (d), increase the sales price by the amount of exempt-interest dividends. Report the loss as a short-term capital loss.
Example. On January 8, 2000, you bought a mutual fund share for $40. On February 3, 2000, the mutual fund paid a $5 dividend from tax-exempt interest, which is not taxable to you. On February 12, 2000, you sold the share for $34. If it were not for the tax-exempt dividend, your loss would be $6 ($40 - $34). However, you must increase the sales price from $34 to $39 (to account for the $5 portion of the loss that is not deductible). You can deduct only $1 as a short-term capital loss.
Capital gain distribution before short-term loss. Generally, if you received capital gain distributions (or had to report undistributed capital gains) on mutual fund shares that you held for 6 months or less and sold at a loss, report only the part of the loss that is more than the capital gain distribution (or undistributed capital gain) as a short-term capital loss. The rest of the loss is reported as a long-term capital loss.
Example. On April 7, 2000, you bought a mutual fund share for $20. On June 25, 2000, the mutual fund paid a capital gain distribution of $2 a share, which is taxed as a long-term capital gain. On July 13, 2000, you sold the share for $17.50. If it were not for the capital gain distribution, your loss would be a short-term loss of $2.50. However, the part of the loss that is not more than the capital gain distribution ($2) must be reported as a long-term capital loss. The remaining $0.50 of the loss can be reported as a short-term capital loss.
Separate your short-term gains and losses from your long-term gains and losses on all the mutual fund shares and other capital assets you disposed of during the year. Then determine your net short-term gain or loss and your net long-term gain or loss.
This topic is covered in a separate article.
Did you sell a security (stock, mutual fund, bond, etc.) at a loss?
Did you purchase or reinvest money in that security 30 days before or 30 days after the sale?
Then the wash sale rule may apply to you.
The loss is not "lost" it is only deferred. If you sell all of the securities - including the "wash sale securities" then you may claim the loss on the tax return.
This IRS rule limits and defers the current deduction of losses in actively traded securities if you buy and sell substantially the same security within a 61-day window (also referred to as being from "30 days before the sale until 30 days after the sale"). This includes both common stocks and put & call options on those stocks as well as other securities. Even if the stock is sold and bought on the same day, the wash sale can apply to that transaction. Short sales likewise are subject to the rule. Having a wife sell her stock followed by a purchase by her husband or by a family controlled corporation, also result in a deferred (or disallowed) tax-loss. This can be a real nightmare for active traders who concentrate in just a few different stocks.
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