Do you frequently trade stocks or purchase options? Then you should be aware of the wash-sales rules. In some extreme circumstances, the wash-sales rules can have drastic negative effects on your taxes, so they are well worth knowing.
A wash-sale occurs when stock, securities, or options are sold for a loss, and within a 61-day period (30-days before or after the sale), “substantially identical” stock, securities, or options (termed here, “replacement stock”) are purchased. The loss is not deductible under the wash-sales rules. Instead, the loss is added to the basis of the replacement stock. Wash-sales do not apply to gains.
The wash-sales rules apply to investors and traders, but not to dealers in stocks or securities, or losses sustained in the ordinary course of business. In general, “substantially identical” refers to stocks or securities of the same company (i.e. shares of Apple stock is not “substantially identical” to Microsoft for purposes of the wash-sales tax rules).
For year-end tax planning purposes, taxpayers should be aware that the wash-sale 61-day rule applies even if duration is spread over two years. Thus, stock sold for a loss in 2010 will not be deductible for tax year 2010 if the replacement stock from the same company is purchased within the 61-day window. Also, for tax planning purposes, keep in mind that the holding period of the replacement stock will include the holding period of the original shares. Thus, if a taxpayer sold shares that were held for more than a year (“long-term” for tax purposes), and then purchased replacement stock within the wash-sales window, the replacement shares will also be considered to be long-term, even if they are eventually sold in less than a year.
Example of the Wash-Sale Rule
A taxpayer buys shares of Widget Company for $20,000. The stock declines to $10,000, and the taxpayer decides to sell the shares for a loss. However, good news is reported from Widget Company after the shares are sold, so the taxpayer decides to buy Widget shares for $12,000 five days after the sale, believing that the shares will increase substantially this time. Because the new shares are purchased within the wash-sale rule time period, the $10,000 loss will not be deductible. Instead the $10,000 will be added to the cost of the new shares, meaning the new shares will have a basis of $22,000 (and thus, the original loss will be deducted when the new shares are sold).
Do you have tax problems or questions relating to your investments? Then give Sherayzen Law Office a call to discuss your tax situation with an experienced Minneapolis tax lawyer!