Tax Return 2021: what is wash-sale loss disallowed?

The wash sale rule essentially discourages those trading securities from taking a loss to simply claim a tax benefit. The general idea when people trade is that you want to buy low and sell high, not vice versa. However guessing the market can be tricky even for the professionals.

The wash-sale rule

Before the law was in place, investors could sell a losing stock and then buy it again a minute later, effectively locking in a loss to reduce their taxes. When you sell a stock at a lower value than the original purchase price you can claim a capital loss on your tax-filing to reduce your tax burden. However if you try to game the system and buy back that losing stock within 30 days when you think it has hit rock bottom you will get hit with the wash-sale rule.

How does the wash-sale rule work?

Under the wash-sale rule, If you buy the same or a “substantially identical security” within 30 calendar days before or after, you cannot deduct a loss on a current-year tax return. Instead, you will have to add the loss to the cost basis of the security you repurchased. Additionally, the holding period of the investment you sold is also added to the holding period of the new investment.

What is a “substantially identical security”?

A substantially identical security is not clearly defined but is determined by the IRS. If that happens, you may end up paying more taxes for the year than you anticipated. If you are not sure if your transaction violates the wash-sale rule consult with a tax professional.

Can I sell the stock at the end of the year and buy it back at the start of the new year?

The wash-sale rules cover 30 days either side of the purchase or sale of a security regardless of the calendar year. So if you sell a stock in the second half of December you cannot buy that same stock or a “substantially identical security” in the first two weeks of January.

Can my spouse buy the stock instead?

No, the IRS has stated that if one spouse sells a stock at a loss and the other spouse purchases it within the restricted time period that qualifies as a wash sale. The same applies for using different accounts to do the transactions.

Short-term capital gains vs. long-term capital gains

Short-term capital gains from investments are normally higher than longer-term capital gains.

Profits from the sale of an asset held for one year or less will be taxed as short-term. Capital gains tax rates on most assets held for less than a year correspond to ordinary income tax brackets (10%, 12%, 22%, 24%, 32%, 35% or 37%).

Profits from the sale of an asset held for more than a year will be taxed as long-term. Capital gains tax rate on assets held for more than a year is 0%, 15% or 20% depending on your taxable income and filing status.

For more information, check IRS publication 550