[1st Jan 2020]

IRS Explanation of Wash Sales

The IRS defines a wash sale as "a sale of stock or securities at a loss within 30 days before or after you buy or acquire in a fully taxable trade, or acquire a contract or option to buy, substantially identical stock or securities."  The wash sale rule under Section 1091 of the Internal Revenue Code (IRC) is intended to prevent investors from generating and recognizing artificial losses in situations where they do not intend to reduce their holdings in the securities that are sold.  For purposes of Section 1091 wash sales occur when an investor realizes a loss on the sale of a security and the investor acquires a "substantially identical" security within a 61-day "window" that extends from 30 days before the date of the sale to 30 days after the date of the sale.  If an investor sells the stock at a loss, and then buys a "substantially identical" replacement stock within this 61-day window, a wash sale occurs and the loss is deferred until the replacement shares are sold. The pro-rata loss is added to the cost basis of the replacement shares purchased, and the holding period of the replacement shares includes the holding period of the original shares sold. However, the deferred loss will eventually be recognized when the replacement shares are sold.  For more information about the IRS and the wash sale rule, please see IRS Publication 550.

For example, consider the case of an investor who purchased 100 shares of Microsoft for $33, sold the shares at $30, and within 30 days bought 100 shares at $32. In this case, while the loss of $300 would be disallowed by the IRS because of the wash sale rule, it can be added to the $3,200 cost of the new purchase.

Tax Planning

• Time Limit Threshold - Wash sales can be avoided by waiting to repurchase replacement shares until after the 30-day window closes.
• Avoid same switch to similar - You can also avoid a wash sale by purchasing similar security, rather than an identical stock, to the one you sold for a loss. For example, if you sold Yahoo for a loss and you were interested in investing in another portal stock, then you could buy Google within the 30-day window and not trigger a wash sale.