End of Year Stock Selling to Offset Capital Gains

A relatively common year-end strategy is to sell underperforming stocks at a loss in order to offset capital gains from other stock sales. Sometimes an investor does not really want to sell the underperforming stock, and quickly repurchases the same or similar stock after the sale. This can be a problem because the transaction may be considered a wash sale. In a wash sale, the loss cannot be taken. Instead the loss is added to the basis of the repurchased stock.

If you are thinking about being clever and buying the replacement stock before you sell the old stock, the IRS had already filled that hole. Here is a small portion of what the IRS has to say about wash sales.

“You cannot deduct losses from sales or trades of stock or securities in a wash sale. 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:

1.       Buy substantially identical stocks   or securities

      2.       Acquire substantially identical stocks or securities in a fully taxable trade
      3.       Acquire a contract or option to buy  substantially identical stock or securities, or
      4.      Acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA”

And, if your spouse or a corporation that you control buys substantially identical stock, you have a wash sale.

If you were involved in day-trading or frequent trading, wash sales can be a real problem because you may not be able to claim a loss until you sell the repurchased stock. On one hand, most people who buy and sell stocks are considered stock investors, as opposed to stock traders. Investors must use Schedule D to report their transactions, and are subject to capital loss limitations and wash sale rules. One the other hand, stock traders report their stock transactions on Form 4797 and related expenses on Schedule C. They are not subject to wash sale rules or capital loss limitations. However, there are strict requirements and procedures that must be followed to be considered a stock trader.

So, if you are planning on taking capital losses to offset capitals gains, wait the appropriate amount of time if you are repurchasing stocks.

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