Subject: Tax Code - Wash Sale Rule

Last-Revised: 11 Mar 2000
Contributed-by: Art Kamlet (artkamlet at aol.com), Rich Carreiro (rlcarr at animato.arlington.ma.us)

A "wash sale" describes the situation in which you sell shares of some security at a loss, and within 30 days you purchase substantially identical securities. At face value, it looks like you took a loss on an investment (would would be deductible from your gross income when you do your taxes), yet you still own that investment, you just now have a lower cost basis. Unfortunately, the IRS does not consider the loss resulting from such a transaction to be deductible. If a sale is considered to be a wash sale, the loss cannot be treated as a capital loss on your federal tax return. In fact, the cost basis of the securities purchased is increased by the amount of that disallowed loss. The goal is to prevent someone from converting a paper loss into a real loss while actually hanging onto that same position.

For the word from the horses mouth, here's a quote from IRS publication 550, "Investment Income and Expenses" (1990), p. 37:

Wash Sales:
You cannot deduct losses from wash sales or trades of stock or securities. However, the gain from these sales is taxable.

A wash sale occurs when you sell stock or securities at a loss and within 30 days before or after the sale you buy or acquire in a fully taxable trade, or acquire a contract or option to buy, substantially identical stock or securities. If you sell stock and your spouse or a corporation you control buys substantially identical stock, you also have a wash sale. You add the disallowed loss to the basis of the new stock or security.

This rule includes normal purchases followed by sales (i.e., you go long, then sell at a later date) as well as short sales and later purchases.

Here's an extended example that may help clarify how the math must be done. The rule is actually rather simple, but when lots of trades are involved it can lead to very complicated situations.

1. 4/01/99 bought 100 at 120.
2. 5/01/99 sold 100 at 110
   The loss was 10 x 100 = $1000.
3. 5/02/99 bought 100 at 95.
   Causes a wash sale of loss on 5/01/99.
4. 5/03/99 sold 100 at 100.
   The gain was 5 x 100 = $500, but you must add the wash sale $1000 into the basis of the purchase on 5/02/99, therefore this turns into a loss of $500.
5. 5/10/99 bought 100 at (any price).
   The sale on 5/03/99 is considered a wash sale even though it became a loss by adding in a wash sale from a previous sale. Stated differently, wash sales can create subsequent wash sales.

The IRS publication goes on explaining all those terms (substantially identical, stock or security, ...). It runs on several pages, too much to type in. You should definitely call IRS for the most updated ones for detail. Phone number: 800-TAX-FORM (800-829-3676). Or visit their web site at http://www.irs.ustreas.gov

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