Wash sale

Wash Sale is a sale of a security (stock, bonds, options) at a loss and repurchasing the same or substantially identical stock soon afterwards. The idea is to make an unrealised loss claimable as a tax deduction, by offsetting against other capital gains in the current or future tax years. The security is repurchased in the hope that it will recover its previous value.

In some tax codes, such as the USA and the UK, tax rules have been introduced to disallow the practice, e.g., if the stock is repurchased within 30 days of its sale. The disallowed loss is added to the basis of the newly acquired security. Tax authorities may consider the practice illegal even in the absence of explicit regulations, on the grounds that the transaction is not genuine, but intended only to reduce tax liability (such as in Australia).

Identifying a Wash Sale

In the USA, per [http://www.irs.gov/pub/irs-pdf/p550.pdf IRS Publication 550] , a wash sale occurs when you sell or trade stock or securities at a loss, and within 30 days before or after the sale you:
* Buy substantially identical stock or securities
* Acquire substantially identical stock or securities in a fully taxable trade, or
* Acquire a contract or option to buy substantially identical stock or securities.

Consequences of a Wash Sale

In USA, the wash sale rule has the following consequences:
# Basis Adjustment: You are not allowed to claim the loss on your sale. Your disallowed loss is added to the basis of the replacement stock.
# Holding Period: Your holding period for the replacement stock includes the holding period of the stock you sold.

Basis Adjustment

After a sale is identified as a wash sale and if the replacement stock is bought within 30 days before or after the sale then the wash sale loss is added to the basis of the replacement stock. The basis adjustment is important as it preserves the benefit of the disallowed loss. You'll receive that benefit on a future sale of the replacement stock.

Note: The identification of a wash sale and adjusting the basis of the replacement stock is an iterative process. Thus, the sale of the replacement stock (after its basis is adjusted) can also be identified as a wash sale if it meets the above defined criteria.

Example: Some time ago you bought 80 shares of XYZ at $50. The stock has declined to $30, and you sell it to take the loss deduction. But then you see some good news on XYZ and buy it back for $32, less than 31 days after the sale. You can't deduct your loss of $20 per share. But you add $20 per share to the basis of your replacement shares. Those shares have a basis of $52 per share: the $32 you paid, plus the $20 wash sale adjustment. In other words, you're treated as if you bought the shares for $52. If you end up selling them for $55, you'll only report $3 per share of gain. And if you sell them for $32 (the same price you paid to buy them), you'll report a loss of $20 per share.

Because of this basis adjustment, the wash sale rule usually does not have a significant impact. In most cases, it simply means you'll get the same tax benefit at a later time. If you receive the benefit later in the same year, the wash sale may have no effect at all on your taxes.

There are times, though, when the wash sale rule can have undesirable consequences.
* If you don't sell the replacement stock in the same year, your basis adjustment benefits will be postponed, possibly to a year when the deduction is of far less value.
* If you die before selling the replacement stock, neither you nor your heirs will benefit from the basis adjustment.
* You can also lose the benefit of the deduction permanently if you sell stock and arrange to have a related person — or your IRA — buy replacement stock.

Holding Period

When you make a wash sale, your holding period for the replacement stock includes the period you held the stock you sold. This rule prevents you from converting a long-term loss into a short-term loss.

Example: You've held shares of XYZ for years and it's been a dog. You sell it at a loss but then buy it back within the wash sale period. When you sell the replacement stock, your gain or loss will be long-term — no matter how soon you sell it.

In many situations you get more tax savings from a short-term loss than a long-term loss, so this rule generally works against you.