It’s important for anyone who buys and sells stock on a regular basis to be aware of tax code policies that can affect you come tax time. We understand that this can be a lot to keep track of—especially for day traders—and not to mention pretty confusing!
The best solution is, of course, to have a professional advise you and handle your taxes so you don’t have to worry about trying to figure out all the rules. However, that doesn’t mean you shouldn’t educate yourself on the tax regulation basics!
Start with our breakdown of one of the most inevitable policies you’ll have to deal with in the trading profession: the wash sale rule.
What is a wash sale?
A wash sale occurs when you sell a stock or security at a loss and then repurchase that same share, or one considered substantially identical, within 30 days before or after the sale. A security is considered “substantially identical” if the underlying stock is the same, like an option or contract on the original stock. As an active trader, you’ll likely make many of these throughout the year without even realizing it!
Wash sales can be made, in theory, in an attempt to claim a loss while maintaining the stock you’ve sold. For example, let’s say you buy a stock for $100 hoping the price would increase over time, but it starts to dip and is now worth $80. You sell the stock to claim a $20 loss on your taxes, then buy it back at $60 the next day. You get to claim a loss but keep the stock—a clever strategy, right? Not quite.
What is the wash sale rule?
It’s hard to pull a fast one on the IRS! The wash sale rule is an IRS regulation that prohibits you from claiming a tax deduction on a stock sold in a wash sale. It was designed to prevent taxpayers from selling a security at a loss so they can claim that loss, and then buy back the same or substantially identical security again.
Capital losses from a wash sale are attached to the cost basis of the replacement security. The capital loss is carried forward until the replacement has finally been disposed of for more than 30 days.
When can the wash sale rule affect my year end profit or loss?
Most wash sales actually don’t impact your year end gains or losses, but there are two scenarios in which they can.
The first is if you sell at a loss in December and repurchase the same or substantially identical shares in January within the 30-day window. In this situation, you’re not allowed to claim this capital loss in the current tax year. The capital loss will move forward with the replacement share until it’s finally liquidated after 30 days.
A similar loss carryover occurs if, at the end of the year, you hold shares open that have accumulated wash sales. The capital loss is disallowed for the current tax year and the repurchased stock will hold both the capital loss and an open position until finally disposed of.
How can I avoid violating the wash sale rule?
To avoid getting caught in the consequences of the wash sale rule, you should closely monitor your stock market trades to avoid putting yourself in the position for a wash sale. Another strategy you can try is to sell your stock, claim the loss, and buy a similar—but not substantially identical—share to replace the one you sold.
All wash sales must be reported on Form 8949 when it comes time to file your taxes. The process can be tedious and complicated. Let Traders Accounting tell you more about how the wash sale rule can affect your assets specifically and handle the work for you with our expert trader tax services! Put your time, focus, and energy into buying and selling, not trying to figure out tax codes.
Contact us for more information and a free 30-minute consultation today!