Wash Sale Losses

Many tax preparers and taxpayers struggle with wash sale loss 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 wash-sale losses 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 challenge for active traders who trade stocks and options, or just options but with constant changes in exercise dates — these are substantially identical positions.

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. 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 throughout the year.

Many traders and tax preparers who are not well versed in the rules may leap to import 1099-Bs into tax software, but they will probably not comply with the rules for taxpayers.

Strategies to avoid wash-sale losses on securities

Consider a “Do Not Trade List” to avoid permanent wash-sale losses between taxable and IRA accounts.

For example, a trader could trade tech stocks in his individual taxable accounts and energy stocks in his IRA accounts. Otherwise, he can never report a wash-sale loss with an IRA, as there is no way to record the loss in the IRA — it’s a permanent wash sale loss.

Taxpayers can “break the chain” on wash-sale losses at year-end in taxable accounts to avoid deferral. If a trader sells Apple equity on Dec. 20, 2019, at a loss, he shouldn’t repurchase Apple equity or Apple equity options until Jan. 21, 2020, avoiding the 30-day window for triggering a wash-sale loss and breaking the chain.

Wash-sale loss adjustments during the year in taxable accounts can be absorbed if traders sell/buy those open positions before year-end and don’t buy/sell them back in 30 days. It means there won’t be a wash-sale loss deferral at year-end.

Consider a Section 475 election. Business traders qualifying for TTS are entitled to elect Section 475 mark-to-market (MTM) accounting, 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 securities 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 a taxpayer elects Section 475, he will need that software to calculate the Section 481(a) adjustment, too. (Learn more about this adjustment in Chapter 2.)

Don’t trade securities. Trade Section 1256 contracts and other financial instruments that are not considered securities for tax purposes, like ETN prepaid forward contracts, cryptocurrencies, precious metals, and swap contracts. Only securities are subject to wash sale loss adjustments.

Excerpt from Green’s 2019 Trader Tax Guide