Year-End Tax Saving Strategy Affected
Somewhere between Halloween and Thanksgiving, you'll start hearing about harvesting tax losses to reduce your taxes (this year). This is a valid strategy. But...you need to beware of the wash sales and the rules surrounding them.
The Congress planned for the potential abuse of this strategy by implementing rules concerning what are called wash sales. The rules say that if you sell a security (stock, mutual fund, ETF, bond) at a loss in a fully taxable transaction, and replace it with a substantially identical security within 30 days before or 30 days after that sale (a total of 61 days), the loss can't be claimed on your current year's taxes. A wash sale also occurs if you purchase an option to buy a substantially identical security within the plus or minus 30 day window. But let's peel back the onion a bit.
To determine whether the security was substantially identical the IRS will look at each case individually. But here are some things we can plan on.
- If you buy and sell the same security or option on that security, it will be a wash sale. Selling IBM stock at a loss and then buying IBM stock would make the transaction a wash sale
- Executing a sell and buy in the same industry would not be a wash sale. An example of this would be selling Coke stock at a loss and buying Pepsi stock.
- Executing a sell of one type of security in one company and buying a different type of security would not be a wash sale. In this case, as an example, you would sell IBM stock at a loss and buy IBM bonds.
- Selling mutual funds or ETFs in different asset classes would not be trigger a wash sale. If you sell the iShares Large Cap ETF at a loss and buy the iShares Mid-Cap ETF, would be an example of a set of transactions that is not a wash sale.
- If the sales involve mutual funds or ETFs from different companies that track the same index, it is less clear but I would lean towards calling it a wash sale. In this case you would sell the iShares MSCI EAFE ETF at a loss and buy the SPDR MSCI EAFE ETF and it would likely be considered a wash sale.
Things to Watch For
If you are selling a mutual fund at a loss, be careful. Depending on whether you sell a portion of your position or you sell after dividends have been paid out and reinvested, you may have wash sale issues.
The wash sale rules apply regardless of where you buy the replacement. So if you sell IBM stock at a loss in your taxable account and buy it in your Roth IRA in the wash sale window, it is a wash sale.
It is also worth noting that wash sale rules do not apply when the sale is for a profit.
What Happens if You Have a Wash Sale?
If you have a wash sale and both transactions are in the same taxable account, then most likely the 1099-B you receive in tax season will show the wash sale and you'll enter that data on your tax return. If the wash sale occurs and two accounts are involved, you'll have to calculate and report the wash sale yourself.
The suspended loss is added to the basis of the replacement security. You'll want to check with the broker involved or mutual fund to determine if they track this for you.
Tax Laws are Complicated
The Tax Cuts and Jobs Act supposedly simplified the tax code. While deductions may be simpler, there is still a lot of complexity in the code. And if you're in the military or retired from the military you have issues that many financial advisors and tax preparers won't be aware of. Make sure you work with one who does or do your own due diligence.
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