Wash Sales

If you both acquire shares (through purchasing or RSU vesting) and sell shares at a loss within 30 days before or after the acquisition, then wash sale rules greatly complicate the tax computations: loss amounts must be allocated to the basis of your acquired shares. The easiest tax-reporting approach is to avoid selling at a loss. Other choices include ignoring the loss for tax reporting or computing the correct values.

• Deferring taxes until later is not always the best strategy. E.g., if your income drops significantly, it may make sense to pay taxes now, but your income will typically need to drop by 1/2 to 3/4 to benefit much.
• An example of the complication is that, if the number N of shares of your loss is less than the number of shares of your acquisition, you must split the acquisition shares into two groups, one with N shares absorbing the loss and one containing all the other shares. Thus, you cannot track share basis based on date anymore.

The wash sale rule prevents you from claiming a “tax loss” if you repurchase the same stock or security (such as an ETF) within 30 days of selling it, but only if your overall trades result in a loss. This leads to confusion because, although you cannot deduct the loss from a wash sale, you also do not owe taxes on any gains from your stock trades unless your overall trades result in a gain.

To clarify, let’s use an example. Say you purchase shares of Coca Cola (KO) at $58 each and the stock price rises to $62, resulting in a gain of $4 per share. You sell the shares and then repurchase them at $63. However, the stock price drops to $59 and you sell, resulting in a loss of $4. So far, your net gain is zero and you do not owe any taxes.

Now, we purchased stock at a price of $58 and sold it at $60. This results in a wash sale for our previous trade (from $63 to $59). Overall, we had a $4 gain, a $4 loss, and a $2 gain from combined trades, leading to a $2 total gain. The middle trade, though a wash sale, does not harm us. Therefore, we only pay taxes on the $2 gain instead of the expected $6 gain.

The wash sale only affects us when we have an overall loss from all our trades. In this case, we cannot claim the loss as a tax write off. However, we also do not have to pay taxes on gains unless we have an overall gain from all our combined trades, including wash sales.

The wash sale rule does not pose a problem for day traders as it does not increase their tax payments. It simply disallows a tax deduction. However, it can be troublesome for individuals who have an overall loss on stocks that are considered wash sales. This prevents them from using the loss to receive a tax benefit.