Wash Sale Rules: What to Look Out For

A common tax savings strategy for investors is to intentionally sell securities with losses to offset gains that have been realized or will be realized in the future (aka tax-loss harvesting). In doing so, you can avoid paying capital gains taxes with the added benefit of avoiding any increases in your taxable income for the year.

While the IRS does allow this tax strategy, they do not, however, allow you to immediately repurchase the position that was sold to book the loss for tax purposes. This where the concept of wash sale rules come in.

Wash Sale Rules

Per the IRS, a wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale you:

1. Buy substantially identical stock or securities,

2. Acquire substantially identical stock or securities in a fully taxable trade,

3. Acquire a contract or option to buy substantially identical stock or securities, or

4. Acquire substantially identical stock for your individual retirement arrangement (IRA) or Roth IRA.

The rule was formed to prevent investors from taking advantage of a loss without ever intending to completely withdraw from an investment. Should you find yourself in a situation where the wash sale rule is breached, the IRS will not allow you to claim the loss deduction on your taxes. This can be especially damaging if the plan was to use these losses to offset any realized gains.

“Substantially Identical”

While the IRS does not provide clear-cut guidance on what is considered a substantially identical purchase, in general, you would want to avoid buying back the same position, even if it is across your accounts. For instance, if a position was sold in a taxable account to book the loss, it cannot be immediately repurchased in a different account (such as a 401(k), IRA, Roth IRA, etc.), hence point #4 mentioned above.

Conclusion

The most obvious solution to avoid triggering this rule is to wait until after the 30-day period has passed to make any repurchases. Having a strong, long-term investment plan will generally help you avoid this type of short-term trigger. Consulting with a fee-only financial advisor can help you develop a proper portfolio allocation as well as a steady tax-loss harvesting strategy.

Weingarten Associates is an independent, fee-only Registered Investment Advisor in Lawrenceville, New Jersey serving Princeton, NJ as well as the Greater Mercer County/Bucks County region. We make a difference in the lives of our clients by providing them with exceptional financial planning, investment management, and tax advice.