What are WASH SALES?

In layman's terms, how can wash sales affect one's year end profit or loss?

• This is about trading/investing in stocks. I’ve read about wash sales online, in articles, on Wikipedia, on my broker’s website, I’ve consulted with a few CPAs, and I still have some confusion about wash-sales as it relates to trading stocks and how they can affect one’s year end profit or loss. There's something I seem to not be getting.   Here’s an example that may help to illustrate my confusion: Assume these two trades take place in 2012 and no trades were made in 2013. The first trade consists of buying shares of XYZ on December 26 and selling all of those shares on December 27 for a loss of $3,000. On December 28 I buy shares of XYZ again, but then realize I didn’t want to be in this position so I sell all of the shares that same day and break even. As a result of this last trade, the $3,000 loss in the first trade is a wash-sale, but I sold the shares from the second trade prior to January 1, 2013. Can I deduct this $3,000 loss for tax-year 2012?   I found this online:   “Actually, there are only 2 conditions where the wash sale rule may affect your year end profit or loss: 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). 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.” Source: http://www.tradelogsoftware.com/tax-topics/wash-sales/how-does-the-irs-wash-rule-affect-me/    As the first sentence in the above alludes to, my main concern relates to how wash sales may affect my year-end profit or loss. In my trading operations I know I will have a lot of wash sales, but that won’t mean a thing to me, it won’t bother me one iota, so long as it doesn’t affect my profit or loss in a negative way at the end of the year. If I have a profit, I don’t want to have to pay taxes on an amount larger than my profits, and if I have a loss I want to be able to deduct as much as possible from my income to pay less taxes.   Is the above quoted true and what else would you be kind enough to share to help explain this in layman’s terms?

• Answer:

  The statements are correct. The intent of the wash sale rule is to prevent a stock trader from selling stock solely to earn a paper loss for tax purposes only to buy back the stock later. Suppose you purchase 1000 shares of XYZ stock at $20 per share in June. The price slides to $10 a share by December. You are still bullish on XYZ in the long term - this is a pharmaceutical company with a potential blockbuster drug which has been delayed in the regulatory process but which you are confident will eventually receive approval. But for right now, for whatever reason, you decide to sell, and on December 15, you sell at $10 per share. You have a loss of $10,000. On January 5, you hear through the grapevine that regulatory approval of XYZ's potential blockbuster will be announced within the next couple of days. When you check, you see that XYZ is now selling for $12.50 per share, and you buy back 1500 shares. You have a wash sale. You can't deduct your loss on the shares you sold in December until you dispose of the stock that you acquired in January, which means that you can't deduct that loss in 2012 at all. Fortunately, the basis on the new shares is adjusted for the loss that you took on the old ones. In this example, the $10,000 loss is added to the $18,750 that you paid for the new shares, so your basis in the new shares is $28,750, or $19.17 per share. When you then sell later, you compute your gain or loss using this adjusted basis. Your holding period for the stock also resets to June, the date that you originally acquired XYZ - which means that if you were to sell XYZ in July, your loss would be long-term loss and not short-term loss. The wash sale rule applies only to losses, as you might expect. The wash sale rule also applies to the 30-day period immediately preceding a sale at a loss - so if you purchased 1000 shares of stock on June 15 at $20 a share, 1000 shares more on December 1 at $15 a share, and then sold 1000 shares on December 15 at $10 a share, you would still have a wash sale, you would still not claim any loss, and your basis in the shares your retained would be $25 a share. This site does a really good job of explaining the wash sale rules: http://www.fairmark.com/capgain/wash/ws101.htm