irs wash sale rule - how does it affact me?

You might be surprised to learn that...

Most wash sales have absolutely no affect on your year end profit or loss!

Yet, if left unchecked, the wash sale rule can have disastrous results at year end. Some of your losses may be disallowed for the current tax year and end up being deferred to a later year, thereby increasing your taxable income in the current year.  This is what is known as a wash sale deferral.

PLEASE READ THIS REAL LIFE ACCOUNT:

In tax year 2000, a trader repeatedly bought and sold anywhere from 400 to 1000 shares of the same stock over a period of several months and never stopped trading this particular stock for more than 30 days. Some trades were profitable, but most were not.  His profitable trades amounted to $7,023. On 12/29/2000 he liquidated all of his shares and took a $117,045 loss. Therefore his net loss at year end totaled $110,022.  He could have stopped right then and there, but for some reason he did not!

What do you think would happen if he re-purchased this same stock on January 2, 2001? 
You guessed it, his entire loss of $117,045 was disallowed for 2000 and he ended up having a net gain of $7,023 for tax year 2000! 

He had an actual net loss of $110,022 on that one stock for tax year 2000, but because of not paying attention to the IRS wash sale rule, he instead had to pay taxes on a gain of $7,023!!

Click here to see the actual details

Now if he continues to trade this stock without letup for at least 31 days, and continues to accrue additional losses, his losses may continue to move forward indefinitely.

Another one of our users did just that. He ended up with losses from one year being deferred to the next year, and the next year, up to 3 years later when he finally stopped trading the losing stock.  All the while he paid taxes on the gains he made on his winning trades.  Now, in both cases their losses were finally realized, but who wants to defer losses to some tax year in the future?  Isn't it a traders worst nightmare to have to pay taxes on money that they did not really make?

Can you see just how damaging this IRS rule can be for some active traders?


Actually, there are only 2 conditions where the wash sale rule may affect your year end profit or loss:

  1. If you sell at a loss in December and then buy it back in January
    If you sell a stock at a loss in December and then buy it back in January (within the 30 day window), the loss is disallowed for the current tax year and has to be moved forward, and can only be realized in whatever year that you finally dispose of the shares that you bought in January.  The same holds when you close a short sale at a loss in December and then enter into another short sale in January (within the 30 day window).
  2. If you hold shares open at year end that have accumulated wash sales
    If you lose on a trade any time during the year and then buy back the same security within the 30 day window, and you hold these shares open at year end, the entire loss is disallowed for the current tax year. The losses now have to be moved forward with the open position, and can only be realized in whatever year that you finally dispose of the shares that you re-purchased.

In either case the loss is disallowed for the current tax year and needs to be deferred to a future tax year. In order to illustrate how this can affect your bottom line, consider the following scenarios:

  • You sell 1000 shares on December 4, 2007 and take a loss of $3,200.00. If you buy back shares of that same stock, or enter into an option trade on that same stock, any time up to January 4, 2008, all or part of your $3,200.00 loss is disallowed for the current 2007 tax year, and must be deferred to a later year according to the IRS wash sale rule.  What this means is that you really lost this amount in December 2007 but you cannot take the loss until you finally sell those re-purchase shares in some later year. 
     
  • You sell 1000 shares on March 15, 2007 and take a loss of $3,200.00. If you buy back shares of that same stock, or enter into an option trade on that same stock, within the 30 day window and hold these shares open at year end.  All or part of your $3,200.00 loss is disallowed for the current 2007 tax year, and must be deferred to a later year according to the IRS wash sale rule.  What this means is that you really lost this amount very early in 2007 but you cannot take the loss until you finally sell those re-purchase shares in some later year.

TradeLog™ makes short work of this nightmare by properly calculating and reporting each and every wash sale that occurs throughout the tax year whether this impacts your year end bottom line or not as required by the IRS. TradeLog™ also handles any wash sale losses that need to be deferred and moves them forward to next year so that you never lose the loss and are able to claim it when you finally dispose of the stock or option. 


But how can I avoid having wash sales negatively affect my bottom line?