When you sell a stock at a loss and repurchase a substantially identical stock within 30 days, your transaction will likely be designated a wash sale. A taxpayer cannot deduct losses incurred from wash sales; however, gains from such sales are taxable. A wash sale results when a taxpayer sells stock or securities at a loss and within 30 days before or after the sale, buys, in a fully taxable trade, substantially identical stock or securities. The wash sale window spans 61 days: 30 days before the sale, the day of the sale, and 30 days after the sale.
The IRS rules on wash sales apply to very similar securities, meaning that transactions involving options, warrants, certain types of preferred stock, and short sales on the security in question within the thirty-day period may count as wash sales.
The rules also applies to a taxpayer’s spouse, or a corporation you control, meaning that a loss-generating sale by one and subsequent purchase by the other may be considered a wash sale, as may agreements among friends to repurchase securities from each other when the wash sale period ends. Further, the IRS does not require that the same number of similar securities be traded in each part of the transaction to count as a wash sale.
One of the requirements of a wash sale is that the stock or securities purchased must be substantially identical to the stock or securities sold. Generally, stock or securities of one corporation are not considered substantially identical to stock or securities of another corporation. They may, however, be considered substantially identical in a reorganization where the stock and securities of the predecessor and successor corporations are substantially identical. Generally, preferred stock of a corporation is not considered substantially identical to the common stock of the same corporation, unless the preferred stock is convertible.
Where the wash sale rules apply, adjustments are made to the holding period and the basis of the property acquired in the transaction that triggered the rule. Generally, the holding period of the security disposed of is tacked onto that of the replacement security. Where a security or share of stock is bought, and such purchase triggers the wash sale rule, the basis of the property acquired (new property) is the acquisition price plus the loss disallowed on the substantially identical securities.
If the number of shares of substantially identical stock or securities you bought within the 30 day period is less than the number of shares of stock or securities you sold, you must determine the particular shares of stock or securities to which the wash sale rules apply. This is done by matching the shares of stock or other securities sold with an equal number of the identical shares or securities bought. The shares should be matched in the same order in which they were acquired. The matched shares and securities are subject to the wash sale rules.
Wash sales does apply to AMT rules, as the rules for calculating regular tax applies to AMT as well.
Claiming tax deductions for losses resulting from wash sales is illegal. Although investment losses are generally tax deductible, selling securities at a loss in order to get a tax benefit and then buying the stock back right away allows tax evaders to create synthetic tax deductions without really changing their positions in a security. Thus, the Tax Reform Act of 1984 allows the IRS to prohibit taxpayers from deducting losses on the sale of an investment if the taxpayer purchases the same security 30 days before or after the sale. This is called the thirty-day wash rule. The Commodity Exchange Act has similar prohibitions regarding wash sales, and wash sales also violate Section 9(a)(1)(A) and Rule 10b-5 of the Securities Exchange Act of 1934. The focus of these rules is on preventing conspiracies to artificially inflate a security’s price by engaging in wash sales, which increase the perceived trading volume of a security and therefore induce legitimate trades by other investors.
Visit – http://www.irs.gov/publications/p550/ch04.html#d0e12591 for in-depth information on Wash Sales.
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