Wash sales allow investors to keep more money in their pockets and lower their tax bills. In the second installment of this two-part series, tax guru Julian Block discusses three strategies for overcoming wash-sale rules that you'll want to know to help clients prepare for the 2022 tax season.
Just joining us? Part one of this two-part series discussed Internal Revenue Code Section 1091, which imposes wash-sale rules that prevent an investor from claiming a current deduction for a loss on the sale of shares of stock if she purchases an identical one within 30 days before or after the sale. This article will discuss a trio of uncomplicated, perfectly legal ways for this client to circumvent the rules and still keep her position in an investment.
Before we discuss these strategies, let’s say your client wants to know the rationale for the rules. It’s a no-brainer. Absent the addition of Section 1091 to the tax code, she and other savvy investors could keep their portfolios intact, yet reap write-offs, just by unloading losers and immediately buying them back.
Let’s say your client is persistent and wants to explore another approach. Is it possible for her to use her IRA to circumvent Section 1091? Nope, according to Revenue Ruling 2008-5. Your client can’t have her IRA quickly buy back stock that she sold at a loss.
I would remind her of another complication. The 30-day period for wash sales can straddle 2021 and 2022. Let’s say that your client sells at a loss on December 31, 2021. The period during which she can’t purchase the same or “substantially identical” securities, as discussed in part one, runs from December 1 through January 30.
Now let's discuss the three strategies.
Your client sells and then buys. The easiest way to nail down a tax loss for 2021 and retain the stock is to sell and then wait more than 30 days before repurchasing. The loss-registering sale can take place as late as the close of trading on the last business day of the year. For 2021, that is Friday, December 31.
This maneuver’s benefit is that it allows your client to get her tax deduction without channeling more money into the market at that point. The drawback is that your client’s tax savings will be trimmed by the amount of any increase in the price of the stock during the waiting period, and she may forfeit some dividend income as well. But if the stock declines, she can replace it at a lower cost, and her tax savings stays the same.
Your client buys, then sells. Let’s say your client buys the same amount that she already holds, waits at least 31 days and then sells her original holding. The IRS imposes a deadline to qualify the loss on her 1040 for 2021. The doubling up has to take place by the end of November, so she can sell by the end of the year.
Besides tying up more money, the drawback is that her loss doubles if the stock falls even more during the 30-day period. Suppose the stock goes up during that time. Then your client makes double what she would have otherwise and perhaps earns dividends. Assuming your client has the necessary cash or credit, when does doubling up on her investment makes sense? Only if she feels confident that the price will increase.
Your client switches. This is yet another uncomplicated tactic that allows your client to bypass the wash-sale problem and remain an investor in the identical industry, but not the identical company. All she has to do is sell her stock and buy shares of a comparable outfit. For instance, she might unload an oil stock and immediately buy shares of another oil outfit.
While the switching needn’t take place on the same day, the deadline to establish a loss for 2021 is the final trading day of the year, December 31. Here, the hitch is that the original investment may outperform the replacement.
Attorney and author Julian Block is frequently quoted in the New York Times, Wall Street Journal, and the Washington Post. He has been cited as “a leading tax professional” (New York Times), an “accomplished writer on taxes...