Wash Sale Rule and its effect on Tax Loss Harvesting
What is the big deal about wash sales?
I screenshot the image above directly from the IRS.gov website.
A wash sale per the IRS = A wash sale is the sale of securities at a loss and the acquisition of same (substantially identical) securities within 30 days of sale date (before or after).
This is the example given, if the image above is too small of a print to read:
The taxpayer buys 100 shares of X stock for $1,000. The taxpayer sells these shares for $750 and within 30 days from the sale buys 100 shares of the same stock for $800. Because the taxpayer bought substantially identical stock, the taxpayer cannot deduct the loss of $250 on the sale. However, the taxpayer adds the disallowed loss of $250 to the cost of the new stock, $800, to obtain the basis in the new stock, which is $1,050.
Maybe you won't be able to claim the loss from that sale that time around, but if you buy the same or similar security or asset at a later time that year, way after the 30 day period, then you technically get to use that "loss" to add to your cost basis on that similar following sale, As shown in the example above, you now increase your cost basis +loss amount, therefore lowering your capital gains anyway once you sell the "second" asset. If you sell it after 30 days at $1000 you in fact even acquire a -$50 loss.
Now the problem arises when we start buying and selling large amounts of dollars, because then if you do not do the equalizing transaction (the second asset transaction) within the same year, you are now stuck with a huge tax bill, since the initial tax loss is disallowed.
This just requires planning and awareness.
Wash sale rules and trading
According to Turbo Tax:
"The wash sale rule also doesn't apply to: sales and trades of commodity, futures contracts, or foreign currencies. Traders in the business of buying and selling securities who use the mark-to-market method of accounting. Securities dealers if their loss is from a transaction made in the ordinary course of business."
Also see the IRS information about this here
However, options trading and wash sale rules are more complicated, since you can have multiple option strategies, some may trigger wash sale rules.
A couple of simple examples
An option with the same strike price and expiration date may qualify as a wash sale.
While an option with different strike and expiration may not, since it can be argued that it is not an identical security.
Selling an option at a loss and buying shares in the security outright is also not a wash sale.
Selling shares in the security at a loss and then buying a call option is considered substantially identical.
If you wanna play it safe, you can always just trade these categories per the IRS: Section 1256 Contracts
Bottomline: IRS wash sale rules can get complicated especially when you are trading options, it is best to seek professional advice from a tax professional that specializes in these types of transactions.
That is all for now.
See you on the next one!
-Pam
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