If you’re planning to adjust your investment portfolio by selling some losing stocks at year-end, take a minute to review the wash sale rules.
A wash sale occurs when you sell a stock, bond, or mutual fund and buy the same or a substantially identical security within 30 days before or after the sale. When this happens, you’re barred from deducting a tax loss on the sale. Instead, your cost basis of the new security is increased by the loss.
Example: Say you sell 100 shares of XYZ mutual fund at a loss of $3 per share. A week later, you regret your decision and buy another 100 shares of XYZ fund. Your original loss of $300 will be disallowed, and you’ll add the $300 to your cost basis in the new shares.
The rules apply to losses generated by transactions involving “substantially identical” stocks and securities, including mutual funds and stock or option grants you receive as part of your compensation. Whether one security is considered substantially identical to another depends on several factors. Generally stocks or bonds in different companies – even those in the same industry – are not substantially identical.
Be aware of a possible trap if you use an automatic purchase plan or dividend reinvestment plan. If these plans cause you to acquire more shares of a stock or fund within 30 days of a sale, the wash sale rules will apply to your sale.
Wash sales can also occur when you repurchase the security in your IRA, or when your spouse or a company you control does the buying.
How can you avoid a wash sale? You can avoid a wash sale if you make your purchase more than 30 days before or after the sale date. Also, you can buy shares in a different but similar stock or mutual fund without triggering a wash sale.
If you have questions about the wash sale rules, please call us.