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Trading and Wash Sales - NEED TO KNOW

Trading and Wash Sales - NEED TO KNOW

March 19, 2021
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Welcome to the Weekly SUMmary - 03/19/2021

Have you ever traded stocks at a loss and not been able to claim the loss? Read on for info as to why this happened.

My last post Trading and Taxes discusses how timing matters related to gains. This post will focus on losses or losses that could have been.

The IRS has great information related to this, but it is somewhat hard to find if you don't know what you're looking for.

I am referring, specifically, to Wash Sales with this post.

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:

  1. Buy substantially identical stock or securities,

  2. Acquire substantially identical stock or securities in a fully taxable trade,

  3. Acquire a contract or option to buy substantially identical stock or securities, or

  4. Acquire substantially identical stock for your individual retirement arrangement (IRA) or Roth IRA."1

This means: "You cannot deduct losses from sales or trades of stock or securities in a wash sale unless the loss was incurred in the ordinary course of your business as a dealer in stock or securities.

If your loss was disallowed because of the wash sale rules, add the disallowed loss to the cost of the new stock or securities (except in (4) above). 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 includes the holding period of the stock or securities sold.

Example

You buy 100 shares of X stock for $1,000. You sell these shares for $750 and within 30 days from the sale you buy 100 shares of the same stock for $800. Because you bought substantially identical stock, you cannot deduct your loss of $250 on the sale. However, you add the disallowed loss of $250 to the cost of the new stock, $800, to obtain your basis in the new stock, which is $1,050.

Substantially identical.

In determining whether stock or securities are substantially identical, you must consider all the facts and circumstances in your particular case. Ordinarily, stocks or securities of one corporation are not considered substantially identical to stocks or securities of another corporation. However, they may be substantially identical in some cases. For example, in a reorganization, the stocks and securities of the predecessor and successor corporations may be substantially identical.

Similarly, bonds or preferred stock of a corporation are not ordinarily considered substantially identical to the common stock of the same corporation. However, where the bonds or preferred stock are convertible into common stock of the same corporation, the relative values, price changes, and other circumstances may make these bonds or preferred stock and the common stock substantially identical. For example, preferred stock is substantially identical to the common stock if the preferred stock:

  • Is convertible into common stock,

  • Has the same voting rights as the common stock,

  • Is subject to the same dividend restrictions,

  • Trades at prices that do not vary significantly from the conversion ratio, and

  • Is unrestricted as to convertibility."1

As you can see, there are many details surrounding the timing of securities sales. These are just a few excerpts from the IRS site (linked below). This is not a comprehensive list of all rules associated with taxation of securities. I would strongly recommend you seek the assistance of a professional if you have any questions related to this topic.

1. https://www.irs.gov/publications/p550#en_US_2019_publink100010557

This is meant for educational purposes only.  It should not be considered investment advice, nor does it constitute a recommendation to take a particular course of action. The hypothetical example is for illustration purposes only and is not intended to be representative of actual results or any specific investment. Waddell & Reed and its representatives do not offer tax advice. Seek professional advice related to the topics discussed.  (03/21)