The Wash Sale Rule
Be mindful that the IRS enforces the wash sale regulation. The wash sale rule is significant for investors reevaluating their market holdings and intending to sell and buy dropping stocks to offset losses. Disallowed losses are a possible consequence of breaking the wash sale rule; therefore, here are some things you should know.
What is the Wash Sale Rule?
According to the wash sale rule, if you buy or acquire a virtually identical stock within 30 days of selling a sinking stock at a loss, you cannot deduct the loss.
A wash sale is when you sell a security at a loss and then repurchase it within a short amount of time.
Losses can balance same-year gains, lowering capital gains taxes. Any residual losses can be deducted from ordinary income (up to $3,000) or carried forward to the next tax year. As a result, many investors choose to sell shares at a loss to decrease taxable gains, a practice known as tax loss harvesting.
What Happens When You Have A Wash Sale?
If you have a wash sale, the capital loss that the IRS disallows is reflected in the cost basis of the replacement stock. This means that if you later sell the replacement stock, the taxable gain will be smaller, while the deductible loss will be more significant.
Furthermore, the new stock's holding time now includes the original stock's holding period. As a result, when you sell the new shares, the gain may be subject to lower long-term capital gains tax rates.
How to Avoid the Wash Sale Rule.
You have a few options if you wish to avoid having the IRS deny your loss due to the wash sale rule.
One option is to avoid repurchasing the identical shares that you previously sold. Remember that the wash sale rule applies 30 days before and after the sale, giving you a 61-day window to avoid buying the identical stock.
Alternatively, if waiting 61 days is not an option, you can buy a security that is not significantly similar to the one you previously sold.
The second approach faces the difficulty of Congress and the IRS failing to define the word "substantially identical." So, what is considered substantially identical under the wash sale rule will be primarily determined by the facts and circumstances of your transaction.
