A wash sale can delay a tax deduction. It occurs when you sell a security for a loss and buy it back within 30 days. Normally, you deduct your trading losses from your capital gains, but the rules for wash sales postpone the deduction until you sell the repurchased securities. If you repurchase the securities in an individual retirement account, you permanently lose the deduction.
Recognizing a Wash Sale
The 30-day repurchase rule applies to securities, and to contracts or options that you can convert into securities, that are substantially identical to the ones you sold. The Internal Revenue Service extends the wash sale rule to securities that you sell in a regular account and repurchase in an IRA. Your broker or mutual fund company will indicate wash sales when it reports your capital gains and losses on Form 1099-B. You receive this form in January, which details the prior year’s securities’ sales.
Postponing the Deduction
You calculate the wash sale when you fill out Form 8949 detailing your capital gains and losses. The form contains separate sections for short-term and long-term capital gains. An investment you sell after holding it for more than one year creates long-term capital gains or losses, subject to lower tax rates.
Each row on Form 8949 represents a particular sale transaction. A row lists the security, the buy and sale dates, the price you paid to buy, the amount you received to sell and the resulting gain or loss. Two additional columns allow you to enter an adjustment and a descriptive code. The deduction you normally would take from a capital loss becomes a “disallowed loss” in a wash sale, which is marked with a code of “W.” You add the disallowed loss as an adjustment to the wash sale, thereby giving a total loss of zero.
Taking the Deduction
The other half of the wash sale calculation occurs when you sell the repurchased securities, which might be in a later tax year. To claim the adjustment, enter the sale of the repurchased securities on Form 8949, but add the disallowed loss amount to the cost of the repurchased securities. This reduces your gain or increases your loss on the sale of the repurchased securities. In other words, it’s a deduction. However, you don’t enter IRA transactions on Form 8949. Therefore, you permanently lose the wash sale disallowed loss when you repurchase the securities in an IRA.
Example of Wash Sale
Suppose that in February, you buy 100 shares of XYZ Corp. common stock for $30 each, or $3,000 in total. On July 1, you sell the shares for $25 each, creating a capital loss of $500. You repurchase 100 shares of XYZ Corp. on July 21 for $27 a share and sell these shares on Nov. 15 for $37 a share. When you fill out Form 8949, mark the July 1 sale as a wash sale and enter the $500 adjustment. Your net loss on the wash sale is the $2,500 sale proceeds minus the $3,000 cost plus the $500 adjustment, or $0.
On the Nov. 15 sale, add the $500 disallowed loss to the $2,700 cost of the shares. Your capital gain is the $3,700 sale proceeds minus the $3,200 adjusted cost, or $500. You thus reap the tax benefit from the $500 loss on the wash sale by reducing your gain on the second sale by $500.
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