Dec 20, 2022

Repurchasing and Selling Stocks? Watch out for the Wash Sale!

What is a Wash Rule? How long is a wash rule timeframe? More in this blog!

Understanding the wash sale rule is crucial if you want to prevent the IRS from disallowing any losses from stock sales and repurchases. It’s a fact stocks have been taking a beating and not to mention the high inflation that we are dealing with. Maybe you're trying to balance your losses by buying and selling sinking stocks. If so, you should proceed with caution. You don't want the wash sale rule to result in the IRS disallowing your losses.

What is the Wash Sale Rule?

To put it simply, a wash sale occurs when you sell a security at a loss to obtain tax benefits, then later repurchase the same security or one that is identical in a short period of time. It doesn't even have to be deliberate. For instance, you might lose some of your tax savings if you just sold a portion of a position for tax loss harvesting purposes and then reinvested profits.

How Does the Wash Sale Rule Work?

How does the wash sale rule work?

You won't be allowed to claim a loss for that security on your tax return for the current year if you want to sell a security at a loss and then buy the same security or one that is nearly identical within 30 days of the sale.

But it does have certain advantages:

In order to reduce future tax obligations, you might add the loss amount back to the cost basis of the new security. Additionally, the holding period for the new security is extended by the holding period for the original security.

The Wash Sale Rule Timeframe

The Internal Revenue Service does not want investors to receive tax benefits by offsetting losses to offset gains. The IRS's position is that you shouldn't be able to deduct the initial loss from your taxes if you promptly repurchase a stock after selling it at a loss or just continue investing in the stock as a result of the buyback.

Let’s look at an example…

Consider buying 50 shares of *insert cool stock name* at $100 each, and then the stock drops to $80. So you lose $1,000 when you sell your 50 shares. However, two weeks following the sale, the price of the *insert cool stock name* stock falls to $50 per share, so you choose to repurchase 50 shares for $2,500. You cannot claim the initial $1,000 capital loss on your tax return for that year because the second transaction was a wash sale.

Is breaking the wash sale rule ALL Bad?

In contrast, some investors may benefit from breaking the wash sale rule. This is so that, in the event of a wash sale, the cost basis of the replacement shares includes the disallowed capital loss. Therefore, any taxable gain is smaller and any deductible loss is greater when you eventually sell the replacement shares. Additionally, the holding time for the first stock is now incorporated into the holding period for the new shares. The gain may therefore be subject to lower long-term capital gains tax rates when you sell the new stock.

Read more: 12 Tax Write-Offs for Your Next Return

Does the Wash Sale Rule Apply to Cryptocurrency?

The majority of securities, including stocks, options, bonds, mutual funds, and exchange traded funds, are subject to the wash sale rule (EFTs). However, cryptocurrency is not currently covered by the wash sale rule. This is due in part to the fact that the IRS views cryptocurrency as property rather than a security. Therefore, you will still be allowed to claim the capital loss under current legislation if you sell cryptocurrency at a loss and acquire it again right away.

Due to the so-called "wash sale rule crypto loophole," investors in cryptocurrencies are now receiving tax deductions for losses that are occasionally regarded as artificial losses. In contrast, owners of stocks and other securities covered by the wash sale rule are not permitted to deduct comparable losses, at least not in the tax year in which the shares were initially sold.

Read more: 5 Reasons You Should Invest In BITCOIN Today

How Can the Wash Sale Rule Be Avoided?

The IRS defines stock that comes from the same corporation, or one that has been reorganized, as “substantially identical” holdings. Knowing how to identify these stocks can help you avoid the wash sale rule. In general, if you're worried about getting hit with a wash sale, you can prevent it by doing the following:

Wait for 30 Days

The best strategy to prevent a wash sale is to wait the full 30 days after selling your investment before purchasing the same or a comparable investment. Additionally, you should confirm that you didn't purchase a comparable or identical investment on the day you sold it or within the 30 days before it.

Look for a materially different investment

Invest in a similar, but not "substantially  identical" investment by using tax loss harvesting, which entails selling one stock to offset the profits of another one. These can be industry-specific ETFs or mutual funds. To be extra cautious, investing in a totally other industry or sector will guarantee that you will not violate the wash sale rule.

TIP: It's usually not a good idea to sell an investment for tax reasons, even if it's losing money. A plan for investing must also be in place to back up the sale. Don't let taxes get in the way of your investment decisions.

Find out the ideal root to take for you by speaking with an agent here!

It goes without saying, it is always best to carefully plan your investments. If investors panic sell and then repurchase the same investment after the market starts to recover, they may unintentionally violate the wash sale rule if they are unprepared for short-term market downturns.

Making the greatest financial and tax decisions for both good and bad times can be aided by having a long-term investment strategy that you stick to, even during market downturns.

Read more: What are the Risks of Crypto Tax Loss Harvesting?

I hope this information was helpful! 

Vincere Tax can help you with the tax implications of business taxes, stocks, bonds, ETFs, cryptocurrency, rental property income, and other investments. 
If you have any questions, feel free to reach out to Vincere Tax here.


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