The IRS wash sale rules affect the investor who sells a security for less than what he paid for it, then repurchases the security at a lower price. This activity generates a capital loss, which under current IRS guidelines should offset capital gains ? thus reducing income normally taxed at the capital gains rate. The wash sale rule prevents traders from purposefully generating losses specifically for the purpose of reducing taxes owed.
What Are Legitimate Wash Sales?
IRS Publication 550 states that individuals 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.? The IRS further defines a wash sale as occurring within 30 days of the date you buy ?substantially? identical stock or securities, including fully taxable trades, options and contracts, or for your IRA or Roth IRA. The rule also applies for corporations and spouses who attempt to avoid taxes through wash sales.
How Wash Sales Affect Profit and Loss
What does this mean for the average investor? It means you cannot take a capital loss on a security you sold and then rebought within 30 days. The silver lining is that the IRS will let you add the amount of the loss to the new amount you purchased, which increases your cost basis ? and reduces your taxes should you ever sell the security for a profit. Securities included in the wash sale rule include stocks, options, bonds and mutual funds. The wash sale rule also applies to IRAs and Roth IRAs, except that if the sale and repurchase occurs in these accounts, the basis for the repurchase is not increased.
Amending a Tax Return for Wash Sale Transactions
If the IRS believes you have violated the wash sale rule, it could wind up a costly mistake. The IRS will not hesitate to fine you for your wash sale violations, so if you think you may have broken this rule in the past, it is probably a good idea to amend your prior year returns to avoid penalties and interests charges.
How to Avoid Breaking the Wash Sale Rules
If you think you can beat the wash sale rules by selling stock in one account and buying it back in another, think again. Plan your sales and repurchases through the lens of your entire portfolio instead, so you are not caught paying fines, penalties and interest. Make sure you abide by the 30-day trade rule so you can safely claim your tax benefit without having to worry about the IRS, and use the first-in, first-out rule if you have made multiple purchases of the same stock. If you plan to invest in volatile securities, avoid trading them in your IRA so you can take advantage of favorable tax policies.
Schedule a Consultation With 212 Tax
For more information on the wash sale rules and how they affect your income taxes, schedule a consultation with the tax accountants at 212 Tax.
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