With more investors trading stocks as a hobby and the number of day traders who have decided to take over their own portfolios, it is incredibly important that you recognize one little nasty piece of the tax code that can hurt you called the wash rule.
The wash rule was set up to more closely define how tax losses can be taken for the short term trading of the same securities. If an individual decided to sell or trade a security they own at a loss and within 30 days of the sale buys a substantially identical stock or security (or an option) their tax losses may be disallowed. Remember, the rule can also apply if your spouse buys a substantial amount of the security as well.
In our current tax code, the wash sale can affect your personal finances with the following consequences.
- You will not be able to “realize” or claim, the loss on the sale
- The disallowed loss is added to the cost basis of the replacement stock
- The holding period of the replacement stock will now include the holding period of the stock you sold.
Take the recent volatility, for example, that you have seen with Twitter. Imagine you bought the stock at $24 a share. Over a few days, the stock drops down to $20 a share, giving you a $4 per share loss. You then decide to sell the stock to take the short-term tax loss. Then, just two weeks later, you decide to rebuy the stock at $19 a share. By making this transaction before the 30 days expire, your tax loss will be disallowed under the Wash Rule scenario.
Far too often investors don’t realize that these rules also apply to exchange traded funds and mutual funds. Make sure you mark your calendar and wait 31 days or you might just wash out some losses that can help you as you approach your year end tax and investment planning.