If you are considering selling stock at a loss to offset gains that you have realized during the year, it is important not to run afoul of the “wash sale” rule.
Under this rule, if you sell stock or securities for a loss and buy substantially identical stock or securities back within a 30-day period before or after the sale date, the loss will be disallowed. The rule is designed to prevent taxpayers from generating a tax loss without relinquishing ownership in a material way. The wash sale rule applies to a 30-day period before or after the sale date to prevent “buying the stock back” before it’s even sold.
The wash sale rule also applies if you repurchase the security in a tax advantaged retirement account, such as IRAs.
Although the loss can’t be claimed on a wash sale, the disallowed amount is added to the cost of the new stock or security acquired. The result is the disallowed amount being claimed when the new stock is finally disposed of in the future.
An example to illustrate
A taxpayer purchases 100 shares of ABCD Inc. for $5,000 and sells them on July 5th for $4,000. On July 30th, you buy 100 shares of ABCD, Inc. again for $4,500. Since the shares were repurchased within 30 days of the sale, the wash sale rule is applicable. Therefore, you can’t claim a $1,000 loss. Your basis in the new 100 shares is $5,500: the actual cost plus the $1,000 disallowed loss.
If only a portion of the stock sold is bought back, only that portion of the loss is disallowed. So, in the above example, if you’d only bought back 60 of the 100 shares (60%), you would be able to claim 40% of the loss on the sale ($400). The remaining $600 loss that is disallowed under the wash sale rule would be added to your cost basis of the 60 shares.
If you have triggered stock gains during the year you may be looking to harvest unrealized losses in your portfolio before year end. This is a great tax planning move. However, it is important not to trigger a wash sale and a disallowed loss. Contact us today for help navigating the wash sale rule.