One of the topics that arise at tax time is about the wash sale rule. If you take it into consideration before taxes and sell your losing positions that have no chance turning green, you can offset your taxes on capital gains. This can be an effective way of paying less capital gain taxes when you file with your tax accountant, but you must avoid the wash rule to claim losses.
What is it?
A wash sale is selling a security that is a loss and purchasing the same security back within 30 days. When you purchase the same security back within 30 days of the sale, you can not report it on your taxes as a loss. Investors will repurchase the security back in hopes of it recovering; but if it does not recover like they thought, you will not only lose more money but you will not be able to claim the loss on your taxes. One thing to note is that the wash sale rule only applies to losses, not gains. You will not be able to offset your capital gain tax by buying the same stock back within 30 days to eliminate reporting a gain.
What is the purpose of it?
The purpose of it, is to prevent investors from selling a stock or security at a loss to offset their capital gain tax and then repurchase the same stock or security back for a gain. The IRS does not want an investor to claim a loss on their taxes, when in reality, the investor sold their position for a day to claim the loss and then bought back the same stock that made them profit in return.
If you are thinking about repurchasing a security that you have sold within 30 days, you should take the following into consideration:
- What has changed that makes you want to repurchase this stock, since you just sold it?
- What is the probability that the security will rise in price?
- Are you conformable with not being able to claim your loss on your taxes if the security drops in price, again?
It is very wise to think carefully about repurchasing a security that you just sold. The determining factor will be if you think the rewards outweigh the risks of repurchasing the security back. The wash sale rule can work against you if you do not plan ahead on selling your securities that are at a loss, so be smart and plan out your sales.