A wash sale is one of many strategies for investors looking to keep more money in their pockets. In this series, tax guru Julian Block explains the wash-sale rules so you can help your clients who are investors lower their tax bill.
It’s no surprise that clients expect their accountants to advise them how to take full advantage of often-overlooked strategies to lower their taxes this year and provide head starts for future years. Ditto for advice on how to steer clear of pitfalls.
A proven way for accountants to display expertise to clients and prospective clients is to explain strategies in understandable language. To help accountants do that, I’m devoting several columns to the much-misunderstood rules for wash sales (Internal Revenue Code Section 1091).
Let’s say your client, a savvy investor, owns stocks that have mostly done well this year, but her holdings include shares in several companies that presently are significantly below their original purchase prices. Now, she wants to sell those losers to recognize tax losses.
I would caution this client to consider the calendar in case she sells and then decides to buy them back because of a gut feeling that those depressed stocks will eventually recover. Unless at least 31 days elapse between the sale and the repurchase, she’ll run afoul of the long-standing “wash-sale” rule and have to forgo her loss.
First, some background about capital losses that your client can use to offset capital gains from sales or redemptions of stocks, bonds, mutual funds and the like. What if there aren’t any gains, or the losses exceed gains?
Code Section 1211 authorizes limited relief. It allows your client to claim a current deduction of as much as $3,000 (dropping to $1,500 each for married couples filing separate returns) of her net losses as an offset against ordinary income from such sources as salaries and other forms of compensation.
What becomes of her unused losses? She has to push them forward for use in future years to soak up any gains and, at a $3,000-a-year clip, to reduce ordinary income.
Back to the wash-sale restriction. It doesn’t apply to a gain on the sale of shares of stock. Your client is free to take her gain and immediately reinvest, though she will, of course, be liable for taxes on her gain. When does the wash-sale rule come into play? Only when she suffers a loss on the shares of stock (including shares of a mutual fund) or securities and then repurchases, or buys an option to purchase, “substantially identical” stock or securities.
How badly do things turn out if your client does that within 30 calendar days (not trading days when the market is open) before or after the sale date, a total period of 61 days? Section 1091 prevents her from using the loss to offset other capital gains until she sells the newly acquired investment.
Your client should be wary of related-party sales. The wash-sale rule also prohibits a loss when she sells stock and then her spouse or a “related party,” such as a corporation controlled by her, buys substantially identical stock.
Suppose your client buys 100 shares of Icarus Airlines for $10,000, which she subsequently sells for $7,500. Within 30 days of the sale, she acquires another 100 shares for $8,000.
Her $2,500 loss is deferred; the new stock’s basis, for purposes of figuring gain or loss, becomes $10,500, which is the sum of the $8,000 cost and the $2,500 disallowed loss.
Another snag: Your client can’t use a wash-sale loss on one block of stock to offset gain on other blocks of stock of the same security sold that same day.
Suppose that on three different occasions, your client buys 100 shares of Krakatoa Audio. Her price per share is $300 for the first block of 100, $200 for the next block and $190 for the last one. At the start of the month, she sells her entire investment at $240 per share. Before the month ends, she repurchases 250 shares. The wash-sale restriction won’t allow her to use her losses to offset any capital gains.
What’s ahead? Part two will discuss some IRS-blessed, uncomplicated ways for your client to circumvent the wash-sale rule and still keep her position in an investment.
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...