Wash-Sale Rule

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What constitutes a wash-sale rule

Wash-sale rule is an internal revenue service (IRS) rule designed to prohibit a tax deduction for the security sold in a wash sale. The rule defines a wash sale as one that occurs when a person sells or trades a security at a loss and within 30 days before or after the sale, buys a “substantially identical” stock or security, or acquires a contract or option to do so. Wash sale also results if an individual sells a security, a spouse or a company controlled by the individual buys similar security.

Breaking down the ‘wash-sale rule

The purpose of the wash-sale rule is to prevent taxpayers from claiming artificial losses. Conversely, if the taxpayer was to see the profit from the sale of securities and within 30 days to purchase an identical replacement securities with the proceeds of this transaction will still be taxed. Sale of options that are defined in the same way as stocks on the loss and recovery of identical variants in the 30-day period will also be subject to the conditions of the wash-sale rule. So the wash-sale period is actually 61 days, consisting of 30 days up to 30 days after the date of sale.

For example, you buy 100 shares of XYZ tech stock on November 1 for $10,000. December 15, the cost of 100 shares fell to $7,000, so you sell the entire position to realize capital loss of $3,000 for tax deduction purposes. 27 December of the same year, you buy 100 shares of XYZ stock technology stock again to regain its position in the warehouse. Start-up losses will not be allowed since the security was repurchased within the limited time interval.

What is a wash Sale

Shares or securities of one company are usually not considered substantially identical by the IRS to another. As well, bonds and preferred shares of the company are also generally not considered substantially identical to shares of the company. However, there may be circumstances in which preference shares, for example, can be considered substantially identical to common stock. This will be the case if the preferred shares are convertible into ordinary shares without any restriction, has the same voting rights as ordinary shares, and trades at a price close to the ratio.
 
If the loss is not excluded on due to the wash sales rules, the taxpayer must add the loss of value of new shares that becomes the basis of the value of the new stock. For example, consider the case when the investor who purchased 100 shares of Microsoft for $33, sold the shares at $30, and within 30 days bought 100 shares at $32. In this case, while losses in the amount of $300 will be denied tax due to wash sales rules, it can be added to the $ 3,200 cost of a new purchase. Thus, the basis of the cost will be $3,500 for 100 shares which were purchased a second time, or $35 per share.

However, there are some simple techniques that you can use to keep yourself in the market until the wash-sale period has expired. Using a fictional company example above, if you sold 100 shares of XYZ Tech stock on December 15, you can purchase the technology exchange-traded Fund (etf) or mutual Fund to maintain a similar position in the technology sector, although this strategy does not fully replicate its original position. When the 30-day period has passed, to sell the Fund or etf and then redeem your shares of XYZ stock if you so desire. Of course, the initial shares may be redeemed prior to the end of the 30-day period, but tax deductions will not be realized.

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