When trading the same stocks or options on those stocks over and over again, hundreds or even thousands of wash sales may be generated throughout the tax year. Therefore, it becomes unbelievably cumbersome to calculate and record each and every wash sale on your schedule d as required by this IRS rule.
IRS publication 550 page 56 states:
| Wash Sales You cannot deduct losses from sales or trades of stock or securities in a wash sale. A wash sale occurs when you sell or trade stock or securities at a loss, and within 30 days before or after the sale you:
If you sell stock and your spouse or a corporation you control buys substantially identical stock, you also have a wash sale. If your loss was disallowed because of the wash sale rules, add the disallowed loss to the cost of the new stock or securities. The result is your basis in the new stock or securities. This adjustment postpones the loss deduction until the disposition of the new stock or securities. Your holding period for the new stock or securities begins on the same day as the holding period of the stock on securities sold. |
This means that if you close a trade at a loss, and then buy back the same, or "substantially" the same equity such as an option on that equity, you cannot take the loss at that time. According to the IRS, the loss now has to move forward, and has to be attached to the cost basis of the trade in which you bought back the same equity.
If that trade now ends in a loss, and you buy the same equity again, the loss gets moved forward again. This can keep happening indefinitely if you continue to keep trading the same equity again and again, and keep ending up with an accumulated loss, and do not stop trading this equity for at least 31 days.
Negative Consequences
If the repurchased shares that triggered the wash sale were 1) held open at year end or 2) purchased in January of next tax year, the IRS says that the loss is disallowed for the current tax year and the loss gets moved forward to next tax year, or whatever year you finally dispose of those shares.
You lost the money this year, but the IRS says you cannot take the loss till next year or later!
In addition, the holding period of a trade may change due to a wash sale. For example, if you close a long term holding at a loss and then buy the it back within the 30 day window, the loss moves into the cost basis of the new trade. If you close the new trade in less than a year at a loss, you now have converted a short term capital loss to a long term capital loss. Since you get more benefit from a short term capital loss than from a long term loss, this negatively affects your taxes.
The IRS wash sale rule is a bit different when it comes to short selling stocks (sell stock short).
IRS publication 550 page 56 states:
| Short sales. The wash sales rules apply to a loss realized on a short sale if you sell, or enter into another short sale of, substantially identical stock or securities within a period beginning 30 days before the date the short sale is complete and ending 30 days after that date. |
Therefore, if you cover, or buy back, your short sale shares at a loss and then sell short the same stock again within the 30 day period, you have a wash sale, and the loss becomes part of your future cost basis when you finally cover the short. This is a bit different in the sense that a sale has triggered the wash sale rather than a purchase.
Because TradeLog accurately matches short sale positions as well as long positions, we are able to properly handle this particular part of the wash sale rule.
Today's active trader has many different trading instruments available to him, and many traders often use a combination of these instruments. Once such combination is trading both stocks and options on stocks. Buying and selling a certain stock and then buying an option on the same underlying stock may seem to be two separate and distinct transactions, but the IRS may choose to differ when it comes to what triggers a wash sale.
The IRS uses the phrase "substantially identical" when it discusses what triggers a wash sale.
IRS publication 550 page 56 states in part:
A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale you:
3. Acquire a contract or option to buy substantially identical stock or securities.
What this means for the stock and options trader is that if you take a loss on a stock or an option, and then buy back that same stock, or an option on that same stock, whether the option is the same month and strike price or not, you have a wash sale. The same holds true if you close an option position for a loss and then buy the same underlying stock within the 30 day window.
There is no clarification in the tax law as to how far "in or out of the money" the option is, or what month and year the option expires. So TradeLog™ simply applies this rule as follows: If the underlying stock is the same, then the option is "substantially" the same.
TradeLog™ and Option Trades as reported by Online Brokers
There is absolutely no standards as to how your brokerage reports stock option trades. Some brokers simply use an option symbol which changes from year to year. Other brokers report these with varying descriptions such as including the underlying stock ticker or description, the expiration month and year (some do not specify the year which is a problem for leaps), the strike price, and whether it was a put or a call.
If there is enough information in the online trade history reports that get imported, TradeLog™ will describe option trades with the long hand notation of the underlying stock symbol, followed by a space, followed by the expiration month and year, followed by a space, followed by the strike price, followed by a space, followed by the word "PUT" or "CALL." This makes it very easy to spot option trades when viewing your trades in TradeLog as well as allowing us to match stock and option trades on the same securities for wash sale calculations.
ex: "MSFT DEC04 45 CALL"
If your broker does not provide enough information to properly identify the option as described above, or if only the option ticker symbol is available in the trade history, then TradeLog cannot possibly match these to the underlying stock. This is one of the problems in this industry where absolutely no standard exists for trade history reporting beyond the basics included in the brokerage 1099.
| The TradeLog Change Option Tickers command converts option ticker symbols into the standard long hand notation as described above. The benefit is that options across all brokers are reported consistently from within TradeLog so that the wash sale rule can be applied consistently across different brokerages. |
The IRS expects you to record each and every wash sale throughout the tax year! For those of you who have ever tried to calculate wash sales for an entire year's worth of trade activity, I don't need to tell you just how painful this can be.
First you need to identify trades that have been closed at a loss. Then you have to scan backwards and forwards in time to see if you re-purchased the same or "substantially the same" securities within a plus or minus 30 day window.
If you did then, you need to record a wash sale adjustment line on your schedule d. You also need to adjust the cost basis of the re-purchase shares, moving the loss forward or backwards to this whatever trade triggered the wash sale.
Does all of this sound complicated? It is if you plan on doing this by hand - see an example of Wash Sales reported on schedule d.
But it gets even more complicated when you do not re-purchase an equal number of shares.
It is inevitable that an active trader will occasionally (and possibly almost never) buy back an equal number of shares after realizing a loss. This is where the wash sale rule starts to really get complicated. IRS publication 550 page 56 states:
"More or less stock bought than sold. If the number of shares of substantially identical stock or securities you buy within 30 days before or after the sale is either more or less than the number of shares you sold, you must determine the particular shares to which the wash sale rules apply. You do this by matching the shares bought with an unequal number of shares sold. Match the shares bought in the same order you bought them, beginning with the first shares bought. The shares or securities so matched are subject to the wash sale rules."
The Net Affect
What this effectively does is to start dividing up your wash sales by the minimum number of shares bought or sold. A couple of simple examples show this quite clearly:
It starts to get very complicated, like the branches on a tree. For an example, please see our Wash Sale Deferral example page. Who has time to figure this out manually?
Since gains and losses realized in an IRA are non taxable, there are no requirements to file any reports with the IRS, nor is there any requirement to calculate wash sales from trading in an IRA account.
However, if you take a loss in a stock in a taxable trading account and then buy that same stock in your IRA within the 30 day window, it may or may not trigger a wash sale according to the IRS wash sale rules. For an interesting discussion on this subject please see the article: Wash Sales: IRAs and Other Related Persons from Fairmark Press.
This begs the question: Since no IRS reporting is required for trades made in an IRA and therefore no wash sales are calculated, how do you report wash sales across taxable and non-taxable accounts? The thought might occur to you to merge any IRA accounts in your tax lot accounting software along with all of your other trading accounts so the software can calculate wash sales between all accounts.
However, losses in the IRA account should not trigger additional wash sales and any gains or losses realized in the IRA account should not be reported to the IRS on schedule d or d-1 attachment. The sad fact is there is no software that we know of that does this, so most traders do not include their IRA accounts for wash sale calculations.
Now there are a few programs out there who claim to handle wash sales properly, but can they handle all 3 of the simple examples as stated above?
One of the most popular tax software programs on the market is TurboTax™. However, TurboTax™ has a very rudimentary wash sale capability in that you can flag a loss trade as a wash sale and it will create a wash sale line item on the schedule d. It will also adjust the cost basis of very next trade in the list.
But what if the next trade is NOT the trade that caused the wash sale? What if the trade that caused the wash sale is for less shares than the loss trade? TurboTax would adjust for the full amount of the loss, when only a portion of the loss should be adjusted for!
This makes using TurboTax to handle your gains and losses from trading including wash sale adjustments quite useless.
NOTICE: Any wash sales or schedule d software that claims to import their gains and losses into TurboTax™ without first adjusting for unequal share trades may be seriously overstating your wash sale losses!
Who wants to take that chance?
TradeLog™ properly calculates wash sales between short and long trades, between unequal numbers of shares bought and sold, and between stocks and options. TradeLog meets the letter of the IRS law unlike many of our competitors. In addition, you can export your wash sale adjusted gains & losses and import them into your copy of TurboTax or TaxCut tax software programs via a TXF file export/import.