As we approach the end of the year it is common for folks to start thinking about how they can reduce their tax bill. If you have recognized some capital gains this year, or are just looking to take advantage of the $3,000 capital loss deduction, you may be considering selling some stock you hold at a loss before the end of the year. Before doing so, make sure you understand the ramifications of the wash sale rules.
Under these rules if you sell stock or securities for a loss and buy substantially identical stock or securities back within the 30-day period before or after the sale date, the loss cannot be claimed for tax purposes. This rule is designed to prevent taxpayers from using the tax benefit of a loss without parting with ownership in any significant way. Note that the rule applies to a 30-day period before or after the sale date to prevent “buying the stock back” before it’s even sold. (If you participate in any dividend reinvestment plans, the wash sale rules may be inadvertently triggered when dividends are reinvested under the plan, if you have separately sold some of the same stock at a loss within the 30-day periods.)
Although the loss cannot be claimed on a wash sale, the disallowed amount is added to the cost of the new stock. Thus, the disallowed amount can be claimed when the new stock is finally disposed of (other than in a wash sale).
Example. Henry buys 500 shares of ABC Corp. for $10,000 and sells them on June 5 for $3,000. On June 30, he buys 500 shares of ABC again for $3,200. Since the stock was “bought back” within 30 days of sale, the wash sale rules apply. Henry cannot claim his $7,000 loss. His basis in his “new” 500 shares is $10,200: the actual cost plus the $7,000 disallowed loss.
If only a portion of the stock sold is bought back, then only that portion of the loss is disallowed. Thus, in the above example, if Henry had only bought back 300 of the 500 shares (60%), he would be able to claim 40% of the loss on the sale ($2,800 under the facts involved). The remaining $4,200 of loss disallowed under the wash sale rules would be added to Henry’s cost of the 300 shares.
Note that while wash sale losses cannot be claimed, gains cannot be avoided. That is, if you sell stock for a gain and buy it right back, you must still report the gain—no special rule applies.
Please let me know if you have any questions on this topic or would like my help in planning future stock transactions.
-Larry