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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AVOIDING WASH SALE PROHIBITION ON LOSS RECOGNITION

Wash sale rules prohibit the recognition of loss on a sale of stock or securities if the investor acquires substantially identical stock or securities during a period that is 30 days prior to the sale of the loss property and 30 days after the sale (i.e., 61-day period). <2>

The provision is intended to prevent an investor from recognizing a loss for tax purposes while ending up in the same financial position as before the sale. Without the prohibition, for example, an investor could sell stock that had lost value, recognize the loss, but immediately repurchase the same stock at the lower value. The investor would end up in the same financial condition, that is, would own the stock, but would have generated a loss for tax purposes.

The wash sale rules prohibit the recognition of such a loss if the taxpayer acquires substantially identical stock or securities at any time during the 61-day period surrounding the sale. It is important to note that it is irrelevant how long the taxpayer may have held the stock or security that is sold. The critical question is the timing of the acquisition of substantially identical stock or securities relevant to the date of sale of the loss property. It must also be noted that the prohibition applies as well if the investor enters into a contract or an option to acquire substantially identical stock or securities.

If the loss is disallowed because of the wash sale rules, the basis of the new stock or securities is determined by adding the disallowed loss to the cost of the new stock or securities. The effect of the adjustment is to postpone the loss deduction until the disposition of the new stock or securities. The holding period for the new stock or securities also includes the holding period for the stock or securities sold. <3>

One strategy for avoiding the wash sale prohibition on loss recognition but still ending up in essentially the same financial condition is to sell the loss stock or securities and immediately purchase stock or securities with underlying characteristics as close as possible to those that were sold without being substantially identical. Thus, while the financial investment would not be precisely the same, it should be close enough so that the investor is in essentially the same financial position, while recognition of the loss on the depreciated property would not be prohibited by the wash sale rules. The critical aspect, of course, is in identifying stock or securities that will not be considered substantially identical. Another common approach is to buy more of the same stock or securities (doubling up) and hope for an eventual upturn in the stock or security's value.

Whether stocks and securities are substantially identical depends on the facts and circumstances of a particular case. Normally, stocks and securities of one corporation are not considered substantially identical to stocks and securities of another corporation, although if the two corporations are merged in a reorganization, for example, they may be so considered. Similarly, different types of stock or securities of the same corporation normally will not be considered substantially identical, although similar characteristics may make them substantially identical. For example, bonds or preferred stock of a corporation normally would not be substantially identical to common stock of the same corporation, although if the preferred stock could be converted into common stock and carried the same voting rights and other similar characteristics, it could be considered substantially identical. Bonds issued by different local housing authorities, even though all guaranteed by the United States, have been regarded as not substantially identical, and the purchase of bonds of one such authority within the proscribed time frame of a sale of bonds of another authority would not prevent the recognition of loss on the sale. <4>

The question of whether a prospective alternative investment may be considered substantially identical to one that may be sold should not be the sole or controlling criteria for determining when to shift out of a deteriorating financial condition. If the wash sale rules do apply, the recognition of the loss in effect is simply deferred to the disposition of the replacing investment.

1/ Applying the Wash Sale Rules, §1091

2/ Code Section 1091.

3/ Code Section 1091(d) IRS Publication 550, Investment Income and Expenses.

4/ Rev. Rul. 59-44, 1959-1 C.B. 205.

AVOIDING WASH SALE PROHIBITION ON LOSS RECOGNITION

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