Wash Sale Dos and Don’ts
The wash-sale rule is designed to prevent abuse of tax deductions. Here are some examples of what would and wouldn’t violate the rule.
Example: You bought 100 shares of XYZ Technology at $30, a software design company. But after bungling their latest product release, shares are selling for $20. You sell all your shares and realize the loss. A week after you sell, the company replaces the CEO responsible for overseeing the flop and shares begin to recover. You could:
- Repurchase shares immediately because you believe in the company’s long-term prospects and now think it’s priced at a bargain. Because you’re repurchasing the same company in less than 30 days, you’d violate the wash-sale rule and negate your tax deduction from selling at a loss.
- Explore other options in the technology space to maintain your allocation. Perhaps some competitors design software but also offer cloud-computing services. As long as the new company is not “substantially identical” to the original one, you would not violate the wash-sale rule and would maintain your tax advantages.
- Wait a few more weeks to see if the rally has legs. If the company seems to have recovered from its missteps after 31 days, you could repurchase the shares. This would not violate the wash-sale rule and you could maintain your tax deduction.
If you’re selling a holding but want to replace it with another that serves a similar purpose, be careful to avoid a wash sale (replacing what you sell with another holding that’s too similar within 30 days). If you violate the wash-sale rule, the capital loss is no longer considered tax deductible (see “Wash Sale Dos and Don’ts").
Things to Keep in Mind
To successfully harvest losses for tax purposes, you’ll need to know how long you’ve held an asset and the price at which you originally purchased it (its cost basis).
If you’ve held an asset for more than a year, it’s considered a long-term holding; less than a year is considered a short-term holding.
The IRS treats long-term investing more favorably: Long-term capital gains are taxed at 0%, 15%, or 20% depending on your income level. Short-term capital gains are taxed at the same rate as your regular income, from 10%-37% using current tax brackets.
There are many ways to determine cost basis, from “first in, first out” to average cost. Frankly, it can get a little tricky. It’s best to work with your financial or tax professional to review records before selling investments for tax-loss harvesting purposes.
Tax-Loss Harvesting: A Benefit for Both Boom and Bust Years
Remember, tax-loss harvesting can help whether your portfolio has had a boom or bust year. Even in a down year without many gains to offset, it could still make sense to harvest your losses to reduce your overall income for the tax year. Any additional losses can be used in future years, too. Think of it as a tax-deduction piggy bank: You can store extra losses from this tax year for another year’s gains down the road.
Wash Sale Dos and Don’ts
The wash-sale rule is designed to prevent abuse of tax deductions. Here are some examples of what would and wouldn’t violate the rule.
Example: You bought 100 shares of XYZ Technology at $30, a software design company. But after bungling their latest product release, shares are selling for $20. You sell all your shares and realize the loss. A week after you sell, the company replaces the CEO responsible for overseeing the flop and shares begin to recover. You could:
- Repurchase shares immediately because you believe in the company’s long-term prospects and now think it’s priced at a bargain. Because you’re repurchasing the same company in less than 30 days, you’d violate the wash-sale rule and negate your tax deduction from selling at a loss.
- Explore other options in the technology space to maintain your allocation. Perhaps some competitors design software but also offer cloud-computing services. As long as the new company is not “substantially identical” to the original one, you would not violate the wash-sale rule and would maintain your tax advantages.
- Wait a few more weeks to see if the rally has legs. If the company seems to have recovered from its missteps after 31 days, you could repurchase the shares. This would not violate the wash-sale rule and you could maintain your tax deduction.
