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Wash-Sale Rule

The wash-sale rule is an IRS policy that prevents a taxpayer from deducting a loss on securities sold in a wash sale. A wash sale occurs when an individual sells or trades a security at a loss and then buys the same or nearly identical stock or security, or acquires a contract or option to do so, within 30 days before or after the sale.

A wash sale occurs when an individual sells a security and his or her spouse or a corporation controlled by the individual purchases a substantially identical investment during the 61-day waiting period.

The rule's purpose is to prevent investors from incurring an investment loss in order to claim a tax deduction while retaining their position in the securities.

How The Wash-Sale Rule Works?

The wash-sale rule is intended to prevent taxpayers from claiming fictitious losses on the sale of assets while retaining ownership of the instruments.

The wash-sale rule has a 61-day deadline. That is, 30 days before and 30 days after the transaction takes place. After that time, the wash-sale rule will no longer apply to transactions involving the same or similar securities.

Whilst the wash-sale rule may disallow a loss, the amount of that loss will be added to the cost of the purchase that triggered the rule. When the position is eventually sold, any loss can be deducted as a tax deduction. As a result, the original loss can be considered to be postponed.

Wash-Sale Rule Example

Assume you pay $10,000 for 100 shares of XYZ tech stock on November 1. On December 15, the value of the 100 shares has fallen to $7,000, so you sell the entire investment to incur a $3,000 capital loss for tax reasons.

On December 27 of the same year, you purchased 100 shares of XYZ tech stock again to re-establish your position in the stock.

Because the investment was repurchased within the wash-sale rule window, the initial loss will not be permitted as a tax loss. It will instead be applied to the cost of the most recent purchase. When you sell those newly purchased shares, the adjusted cost basis will be utilized to calculate your gain or loss.

Benefits Of Understanding Wash Sales

You will be able to take advantage of valid tax benefits without getting into trouble with the IRS if you are familiar with wash sales and the wash-sale rule. Knowing more about the subject can help you make sure that you:

  1. Get the tax deductions you planned on rather than having them denied.
  2. Can be used in conjunction with the rule's waiting period and significant tax deadlines.
  3. After selling your original investment, purchase suitable, linked securities to maintain your expected appreciation.
  4. Stay in the market and avoid the consequences of disobeying the regulation.
  5. Can determine when a rule won't affect your transactions.

What's The Penalty For Violating The Wash-Sale Rule?

There isn't a true penalty. Any attempt to claim a loss as a tax deduction will be rejected if your transaction is in violation of the wash-sale rule. The purchase price of the security you acquired that broke the wash-sale rule must be increased by the amount of the loss. This delays the loss deduction until the security is sold, according to the IRS.

Conclusion

  • A wash sale happens when a trader sells a position at a loss and then purchases the same security (or one that is very similar) within the allotted 61 days.
  • Also, it happens if a firm they own or control purchases substantially identical securities within that time.
  • The IRS sees this as producing fictitious losses to qualify for tax advantages.
  • According to the wash-sale rule, taxpayers cannot deduct an unjustified capital loss from taxable earnings.
  • Investors should be aware of the wash-sale regulation so they can take preventative measures.
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