Wash Sales

The last critical piece of tax code pertaining to investment income that you need to know concerns wash sales: dumping securities that are now worth less than you paid for them, taking the loss for tax purposes, and then buying them back immediately at the low cost. The IRS is wise to that old shell game. It is illegal. Don't do it.

The IRS has a 30-day wash-sale rule, where a taxpayer cannot recognize a loss on an investment if that investment (or a similar investment) was purchased within 30 days before or after the sale, including the actual day of the sale.

For example, if you bought 100 shares of XYZ on Nov 1 and then sold 100 shares of XYZ on Nov 28 at a loss, the loss deduction would not be allowed. Similarly, short selling ABC on Nov 15 and then closing the position by buying ABC on Dec 10 does not permit a deduction.

"Substantially Identical" Securities
In most circumstances, shares from different companies, or bonds and preferred shares of the same company are not considered "substantially identical" under IRS rules. However, the IRS warns that individuals must consider more than the security itself in determining whether or not it is considered identical, such as whether the shares are related due to a reorganization of the underlying company.

In general, convertible bonds, convertible preferred shares, and call or put options that can be converted into common shares that have been bought or sold by the investor are considered substantially identical.

Excluded from the wash sale rules are:

  • Any loss arising from a section 1256 contract, which includes regulated futures contracts, foreign currency contracts, nonequity options, dealer equity option, or dealer securities futures contract.
  • In most cases, nonconvertible securities.


Look Out!
The IRS also considers similar securities that are bought and sold within the 61 day window. For example, an investor purchased ABC stock on October 15th for $40 and then sold it on October 31st for $35. A few days later, on November 5th the investor then purchased a call option on ABC stock. Consequently, this investor would not qualify for a tax deduction for the loss incurred on their purchase and sale of ABC stock, and would have to add $5 ($40-$35) to the cost of the option.


The IRS provides an excellent publication detailing the rules and examples of various situations that can arise. We strongly recommend a read of the following information in IRS Publication 550 (2005), Investment Income and Expenses
.



Rules Regulating SROs

Related Articles
  1. Managing Wealth

    How to Avoid Violating Wash Sale Rules When Realizing Tax Losses

    How to avoid violating the IRS wash sale rules when realizing capital losses in your taxable investment account.
  2. Managing Wealth

    Explaining the Wash Sale Rule

    The wash sale rule is a provision that prohibits taxpayers from creating artificial losses by selling stocks and bonds at a loss, then repurchasing them.
  3. Investing

    Washing Trades In A Canadian Registered Account

    For Canadian RRSP accounts, washing same-day trades and using money market funds to bridge the gap over a multi-day trading period saves investors the exchange fee and will help their bottom ...
  4. Trading

    How Are Futures & Options Taxed?

    We present a basic introduction to the US tax processes of futures and options.
  5. Financial Advisor

    Using Tax-Loss Harvesting to Keep Your Gains

    Harvesting tax losses is a key skill that investors can use to keep more of their money in their pockets the next time they file taxes.
  6. Financial Advisor

    Top Tips for Deducting Stock Losses

    Investors who know the rules can turn their losing picks into tax savings. Here's how to deduct your stock losses.
  7. Markets

    What is the Price-to-Sales Ratio?

    The price-to-sales ratio is an indicator of the value placed on each dollar of a company’s sales or revenues.
  8. Trading

    Tax Treatment For Call & Put Options

    A brief intro to the complex US tax rules governing call and put options with examples of some common scenarios.
  9. Financial Advisor

    Top Tax Planning Tips for Volatile Markets

    Volatile markets provide several ways to lower tax bills ... if you play your cards right.
  10. ETFs & Mutual Funds

    Leverage Your Returns With A Convertible Hedge

    Find out how you can maintain your income stream by using this type of bond strategy.
Trading Center