Wash Sale Rules Defined
Generally speaking, the Wash Sale Rule is an IRS rule that prohibits a taxpayer from claiming a loss on the sale or trade of a security in a wash sale. Said another way this rule defines a wash sale as one that occurs when an individual sells or trades a security at a loss, and within 30 days before or after this sale, buys a “substantially identical” stock or security, or acquires a contract or option to do so. A wash sale also results if an individual sells a security, and the spouse or a company controlled by the individuals buys a substantially equivalent security. The Wash sale rule applies to traders the same way it applies to investors. The difference is that traders have a much harder time keeping records relating to wash sales because they engage in so hundreds of transactions. This rule does not apply to gains, but only to losses. Naturally, the IRS prefers to tax all of your gains!
HOW TO AVOID WASH SALES
If you make hundreds or thousands of trades each year, the record keeping required for compliance with the wash sale rule can be nearly impossible. There are several ways to eliminate the problem for active traders. The first way to avoid the wash sale rule is to simply wait for 31 days after you sold the stock or option before you buy it back. The second way is to elect the mark-to- market accounting method. To make the election a trader must qualify for trader tax status. In general, a trader must make the mark-to-market election by the due date (not including extensions) of the tax return for the year prior to the year for which the election becomes effective. You can make the election by attaching a statement either to your income tax return or to a request for an extension of time to file your return. The statement should include the following information:
That you’re making an election under section 475(f);
The first tax year for which the election is effective; and
The trade or business for which you’re making the election
There are some other important things you should know if you’re thinking of making this election:
All of your trading gains and losses will be treated as ordinary income; there will be no capital gains treatment. If a trader is carrying a capital loss, they cannot be used to offset ordinary gains (capital losses only offset capital losses)
Any stock or security you hold at the end of the year is marked to market. This means you report gain or loss as if you sold it at the close of business on the last trading day of the year for its fair market value.
Once you make this election you’re stuck with it. You can revoke it only with the consent of the IRS.
Be careful when electing the mark to market method. If you make any mistakes or miss any deadlines on sending in the right forms, you will lose out on the mark to market tax benefits for that year. Please consult a CPA, Lawyer, or tax professional if you are considering making the election. If you use our tax preparation and planning services and not currently using mark to market accounting we can help sort your trades across all brokerage accounts to identify wash sales.
ADDITIONAL RULES ABOUT WASH SALES
Below are several different items you need to consider when you deal with the wash sale rules:
If you bought identical shares within the previous 30 days that
aren’t replacement shares, it is not a wash sale.
There are mechanical rules to handle the situation where you don’t buy exactly the same number of shares you sold, or where you bought and sold multiple lots of shares.
Your loss may be disallowed if a person who’s related to you (or an entity related to you such as an IRA) buys replacement property.
During the wash sale period, if you enter into a contract or option to acquire replacement stock, that will be considered a wash sale.
If you don’t sell the replacement stock in the same year, your loss will be postponed, possibly to a year when the deduction is of far less value.
If you die before selling the replacement stock, neither you nor your heirs will benefit from the basis adjustment.
You can also lose the benefit of the deduction permanently if you sell stock and arrange to have a related person – or your IRA – buy replacement stock.
