Investors, be careful: Don't get soaked by the "wash sale" rule. Even sophisticated investors sometimes get hosed. Here is how the rule generally works and how to avoid trouble.
The issue often arises around this time of year as tax-savvy investors do "tax-loss harvesting"—selling investments at a loss in order to trim taxes.
Capital losses can soak up capital gains on a dollar-for-dollar basis. If your losses exceed your gains, deduct as much as $3,000 a year ($1,500 if married but filing separately) of those net capital losses from wages and other ordinary income. Carry over additional losses into future years.
Don't make investment moves such as this solely for tax reasons. But if you are selling some losers anyway for investment reasons, it can pay to be aware of the wash-sale rule. "More investors need a friendly reminder" of the rule and its implications, "especially at a time like now" when considering year-end tax planning strategies, says Amy Vega, senior tax manager at Grant Thornton LLP in New York.
A wash sale typically occurs when you sell a stock or other securities at a loss—and, within 30 days before or after the sale, you buy the same stock, or something "substantially identical," the IRS says. With a wash sale, you aren't allowed to deduct your loss. (Instead, add the disallowed loss to the cost of your new stock. The result is your "basis" in the new stock.)
It isn't hard to avoid problems. If you sell something at a loss, don't buy the same thing within the prescribed time period. "You may be able to buy securities of a different company in the same industry or shares in a mutual fund that holds securities much like the ones you sold," says a year-end tax guide by Grant Thornton.
For more, see IRS Publication 550, or find a trusty tax pro.
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