Wash Sale Losses

Many tax preparers and taxpayers struggle with wash sale loss rules

Congress doesn’t want taxpayers to realize “tax losses” that are not “economic losses.” If you close a transaction and re-open it right away, you haven’t closed your financial position in that security. At year-end, many taxpayers do “tax loss selling” of securities in December, and the IRS wash sale rules defer the loss if the taxpayer re-purchases a substantially identical position within 30 days before or after, which means into January of the subsequent year. 30 days is an eternity for day and swing traders.

Section 1091 Wash Sale Rules Per IRS Publication 550:

  • A wash sale occurs when you (a taxpayer) sell or trade stock or securities at a loss and within 30 days before or after the sale you:
  • Buy substantially identical stock or securities,
  • Acquire substantially identical stock or securities in a fully taxable trade,
  • Acquire a contract or option to buy substantially identical stock or securities, or
  • Acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA.

Wash-Sale Rules Differ Between Brokers And Taxpayers

IRS regulations for Section 1091 require taxpayers to calculate wash sales based on “substantially identical” positions. That’s different from the rule for brokers that require “identical” positions. This can be a problem or challenge for active traders who trade stocks and options, or just options but with constant changes in exercise dates. Starting in 2014, 1099-Bs included equity options for the first time.

Many brokers report “disallowed wash sales for the year” on 1099-Bs rather than “actual wash sales” at year-end. This causes confusion and anxiety for many taxpayers, who draw the wrong conclusion and may think they have a huge problem at year-end, when they may not. The “disallowed wash sales for the year” number may count the same wash sale over and over throughout the year. What counts more is what wash sales are deferred at year-end, and what ones were permanently lost to IRA accounts.

Many traders and local tax preparers who are not that savvy to the wash sale rules may leap to import 1099-Bs into TurboTax, but they will probably not comply with Section 1091. In effect, they are using broker rules and unknowingly or willfully disregarding Section 1091.

Strategies To Avoid Wash Sale Losses

Consider a “Do Not Trade List” to avoid permanent wash sale losses between taxable and IRA accounts. For example, trade tech stocks in your individual taxable accounts and energy stocks in your IRA accounts. Otherwise, you can never report a wash sale loss with an IRA, as there is no way to record the loss in the IRA.

Break the chain on wash sale losses at year-end in taxable accounts to avoid wash sale loss deferral to 2018. If you sell Apple equity on Dec. 20, 2017 at a loss, don’t repurchase Apple equity or Apple equity options until Jan. 21, 2018, avoiding the 30-day window for triggering a wash sale loss. Wash sale loss adjustments during the year in taxable accounts can be realized if you sell/buy those open positions before year-end and don’t buy/sell them back in 30 days.

Industry Practice

Many tax preparers, including CPAs, import or attach broker 1099-Bs to generate tax return Form 8949; they don’t account for wash sales based on IRS rules for taxpayers. It’s become a widespread industry practice, and I have not heard about the IRS challenging it to date. If you plan to use this industry practice (at your risk), it’s wise to avoid wash sale loss conditions in the first place, so there are few gaps in broker vs. taxpayer rules. The crucial period is Dec. 1 through Jan. 31, covering the 30-day window on each side of year-end for triggering wash sales among taxable accounts. (That includes both spouses’ accounts on a married filing joint tax return.)

Consider A Section 475 Election

Business traders qualifying for TTS are entitled to elect Section 475 mark-to-market (MTM) accounting elected on a timely basis, which exempts them from wash sale loss adjustments and the capital loss limitation. Section 475 business trades are not reported on Form 8949; they use Form 4797 Part II (ordinary gain or loss). Although Section 475 extricates traders from the compliance headaches of Form 8949, it does not change their requirement for line-by-line reporting on Form 4797. We recommend trade accounting software to generate Form 4797. If you elect Section 475, you’ll need that software to calculate your Section 481(a) adjustment, too. (Learn more about the Section 481(a) adjustment in Chapter 2.)

For more in-depth information on wash sale tax treatment, see Form 8949 & Form 1099-B Issues and read Green’s 2017 Trader Tax Guide.