The wash-sale rule is an Internal Revenue Service (IRS) regulation initiated to intercept a taxpayer from enjoying a tax deduction for a security sold in a wash sale.
A common methodology implemented by traders to avoid the wash-loss rule is to sell a security and buy something with identical exposure. This practice is commonly executed with ETFs.
What is The Wash Sale Rule
A wash sale occurs when a security is sold or traded at a loss, and later a ‘substantially identical” stock or security is bought by the trader, or a contract is acquired for the same within 30 days before or after the sale.
- The wash-sale rule has been implemented to disallow people from claiming tax relaxation on capital gains.
- A wash sale occurs when you sell a stock at a loss and then invest in that same stock or “substantially identical” securities within a period of 30 days (before or after the sale date).
- Your loss will be disallowed if you make the above transaction within a time of 30 days and added to the cost basis of the securities you invested in.
If an individual continues to trade the same or substantially similar stock, then with each transaction, the loss also gets forwarded. IRS closely monitors people’s accounts in order to track any repurchase of identical stocks. It prevents people from claiming fabricated tax losses.
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Tax Loss Harvesting
In tax-loss harvesting, you sell-off your stocks/fund units at a loss for the sake of reduction of tax liability on capital gains made overall with selling profitable stocks.
Tax Loss Harvesting is extremely helpful in saving taxes. Once the losses are sold, one should wait for 30 days before investing in a substantially similar stock. This practice is encouraged to avoid wash sales.
Taxpayers minimize their capital gains to avoid paying high taxes. After selling-off their stocks at a loss, investors often buy the same or similar stocks/fund units to account for the loss.
To successfully harvest a tax loss, one is required to monitor his/her asset allocations, and ensure that the replacement assets purchased aren’t substantially identical. This is an effective strategy to avoid wash sales and gain success.
Protocols Undertaken to Avoid Wash Sales
There are a couple of tricks and strategies that you can pull off to steer clear of wash sales.
1. Added Investments While Keeping Stocks At a Loss
If an individual owns stock with a loss and intends to sell it but also doesn’t want to be out of the market, there is a simple strategy to follow. One should invest in another additional stock and then wait for at least 31 days to sell off the stocks bearing a loss.
2. Investing in Similar Stocks Wisely
One must invest in stocks that are similar but not substantially identical to the investment been sold off if one intends to remain invested in a similarly-yielding investment.
3. Entity Account Trading
Trading in an entity account to avoid wash sale losses is also a viable idea. This is primarily because the company’s account is regarded as separate from the individual or IRA accounts. This practice is done to avoid wash sales.
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4. Regaining Sold Stocks Partially
Traders often consider the ideology of something is better than nothing by implementing partial deduction. This would let you have a fraction of your investment by selling a relatively greater number of stocks than what is bought later within the 61 days surrounding the transaction.
Consider that you own 1,000 shares of ABC and trade them all at a loss, only to purchase 200 of them later, which is a relatively smaller number than what was sold.
Here, the disallowed loss and 200 shares sold are included in the cost basis of the 200 new stocks purchased. The remnant loss doesn’t vanish but is only delayed to be tackled later.
5. RS-compliant Trade Accounting Software
One can even consider using an IRS-compliant trade accounting software or a professional service using such software. A meticulous implementation of the software enables traders to neglect WS loss adjustments with potential WS loss reports.
6. Implementing Taxable and IRA Accounts
This strategy of avoiding a wash sale loss employs the concept of trading with both taxable and IRA accounts. If a stock is sold in a taxable account and a substantially identical stock is bought within 30 days in an IRA account, the WS loss can be avoided wholly.
Brokers don’t calculate WS losses across more than one account at a time; hence they don’t report the wash sale. If one trades specifically in an IRA alone, then WS sales are avoided.
A wash sale is monitored closely by the IRS; thus, it is advisable to avoid it by simply waiting out the 61 days tenure and invest in similar stocks after this period.
The wash-sale rule is the IRS’s way of limiting stock sales that are influenced mainly due to tax reasons. Some investors don’t appreciate it, while some consider it valuable and yielding.
Investors often avoid it to reduce taxes or find their ways to work around a wash sale. Its always good to keep your portfolio clean
It’s arduous to avoid triggering a wash sale and, depending on the situation, it might not always be one’s best bet to avoid a wash sale and minimize gains.
In consultation with the client, explaining the trade-offs is always helpful, whether they employ ideologies to avoid wash sales or simply accept them or even devise ways to work around a wash sale rule.