Tag Archives: accounting

How To Avoid Taxes On Wash Sale Losses

August 5, 2019 | By: Robert A. Green, CPA | Read it on

Many securities traders incur significant tax bills on phantom income caused by “wash sale losses disallowed” on form 1099-Bs. Traders are often surprised because most brokers don’t report wash sale (WS) loss calculations during the year. In this blog post, learn how to deal with WS loss adjustments and how to avoid them in the first place.

WS loss reporting on 1099-Bs is confusing
Broker 1099-Bs report “wash sale loss disallowed” (box 1g), and it’s not uncommon to see an enormous amount for an active securities trader. The 1099-B also reports “proceeds” (box 1d), “cost or other basis” (box 1e) and several other related amounts. For example, $10M proceeds minus $9.9M cost or other basis, plus $150,000 of wash sale loss disallowed, equals $250,000 of taxable capital gains. The 1099-B cover page has summary numbers, and supplemental schedules include each securities trade for all of these boxes.

The essential point is that WS loss disallowed in box 1g is for the entire tax year. However, WS losses deferred at year-end cause phantom income in the current tax year. Many WS losses during the year might fade away by year-end (see how below). Unfortunately, brokers do not report WS losses deferred at year-end, and clients need that information. If a trader uses trade accounting software, they need this information to reverse WS loss deferrals from the prior year-end on January 1 of the current tax year.

For example, two different traders can have $1M of WS loss disallowed in box 1g. Trader A doesn’t have WS losses at year-end, and she is not concerned with those adjustments during the year. She sold all open positions by year-end and did not repurchase substantially identical positions in January. Trader B also sold all positions by year-end, but he made repurchase trades in January, which triggered $50,000 of WS losses deferred at year-end. Trader B delayed the December WS loss to the subsequent tax year.

Traders need ongoing WS loss information throughout the year to prevent this predicament. Some monthly brokerage statements include cost basis amounts for month-end open positions listed on the report, and other monthly brokerage statements do not.

Most traders don’t realize they have a WS loss problem until they receive 1099-Bs in late February. That’s too late to avoid WS losses. Some traders and tax preparers import 1099-Bs into tax preparation software. Others enter the amounts to Form 8949 and then attach the 1099-B for details. If the taxpayer has cost basis adjustments, the IRS requires Form 8949; listing each securities proceeds, cost basis, WS losses, and other cost basis adjustments. However, there’s a problem relying solely on 1099-Bs because IRS WS rules for taxpayers vary from WS rules for brokers in preparing those 1099-Bs.

WS rules for taxpayers and brokers are different
Taxpayers must calculate WS losses based on “substantially identical securities” (i.e., Apple equity vs. Apple options), across all taxpayer’s brokerage accounts, including IRAs and spousal accounts if married/filing joint. Conversely, brokers calculate WS based on “identical securities” (an exact symbol) per the one brokerage account. This apples vs. oranges is problematic since the IRS seeks to match broker 1099-Bs to Form 8949 prepared by taxpayers.

Trade accounting software can help
Traders should consider using an IRS-compliant trade accounting software or a professional service using such software. Contemporaneous use of the program allows traders to avoid WS loss adjustments with potential WS loss reports. The software/service also gives taxpayers a second opinion vs. broker 1099-Bs.

Taxpayers and accountants are entitled to depart from 1099-Bs and explain why in the tax return footnotes. For example, a 1099-B might treat an ETN prepaid forward contract (i.e., BATS: VXX) as a security with wash sales. However, an ETN structured as a prepaid forward contract (PFC) is not a security, so WS losses don’t apply. A CBOE-listed option on an ETN/PFC is a “non-equity option” in Section 1256, although most 1099-Bs treat these options as securities subject to WS losses. Many brokers rely on tax treatment provided by exchanges, who try to fit financial instruments into two boxes: securities vs. section 1256 contracts.

Traders should try to reconcile Form 8949 proceeds with 1099-B proceeds. However, they should not expect to match cost-basis information, if trade accounting software calculates WS losses differently.

Trade accounting software downloads all trades, and the program automatically calculates WS losses based on IRS rules for taxpayers, not brokers. The program explains the rationale and provides details on various tax reports.

The 1099-Bs might use FIFO or specific identification and try to reflect the same accounting method in a trade accounting program.

For the first year of using trade accounting software, traders should enter open positions from the prior year-end with original-cost basis. Additionally, traders should enter deferred WS losses applied to those open positions. Traders should also enter WS losses deferred on closed-positions repurchased within 30 days in January. Trade accounting programs do not download this information from the prior year.

It would come in handy if the broker provided the WS loss deferred at year-end. If that amount was available, you could enter it as a cost basis adjustment, in addition to open positions with an original cost basis.

In the second year of use, the trade accounting program will automatically carry over open positions and wash sale loss adjustments from the prior year. Consult the program vendor and or trade accounting expert.

Jason Derbyshire of TradeLog software says: “If brokers provide detailed reporting of WS loss deferrals at year-end, TradeLog could utilize that information to help automate input into the software. This information would enable traders to accurately track those deferred losses in the software, and make more informed decisions to capture those losses, if needed, in the following tax year.”

What exactly is a wash sale loss?
A wash-sales loss is a timing issue. If you sell a security for a loss and repurchase it 30 days before or after, you cannot deduct the economic loss immediately in a taxable account. You must add the WS loss to the replacement position’s cost basis, which kicks the can (loss) down the road.

WS loss adjustments made during the year in taxable accounts might not be a problem at year-end. Some fade away. For example, a trader can trigger a WS loss every month during the year but absorb it with a significant capital gain on that security toward year-end. Additionally, the trader can “break the chain” at year-end by selling the position and not repurchasing it for 30 days.

There are also permanent WS losses triggered by IRAs, which are catastrophic. When you sell a position at a loss in a taxable account and repurchase a substantially identical position within 30 days in an IRA, there is no way to record the WS loss. Brokers don’t report these types of WS losses since they don’t calculate WS across more than one account at a time. If you trade in an IRA only (i.e., you do not trade in taxable accounts), then you don’t have these WS loss issues.

Strategies to avoid wash-sale losses
Consider a “Do Not Trade List” to prevent permanent WS between taxable and IRA accounts. For example, a trader could trade tech stocks in his taxable accounts and energy stocks in his IRA accounts.

Taxpayers can “break the chain” on WS losses at year-end in taxable accounts to avoid deferral. If a trader sells Apple equity at a loss on December 20, 2019, consider not repurchasing Apple equity or Apple equity options until January 21, 2020. That avoids the 30-day window for triggering a WS loss. In December 2018, many traders realized tax losses before year-end with a market correction. Some didn’t want to wait 30 days and miss the January 2019 rally, thereby triggering significant WS loss deferral at year-end 2018. Deferral of WS losses can become a problem if it causes a capital loss limitation in the subsequent tax year.

WS loss adjustments during the year in taxable accounts can be absorbed if traders sell/buy those open positions before year-end with a profit.

Consider a Section 475 election. Traders eligible for trader tax status (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. I call it “tax loss insurance.” Don’t enter Section 475 trades on Form 8949; 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 the requirement for reporting each trade on Form 4797.

We recommend trade accounting software to generate Form 4797. If a taxpayer elects Section 475, she will need that software to calculate a Section 481(a) adjustment, too. Even with a Section 475 election, the trader still needs to make the manual entries for open positions and opening-year WS loss adjustments mentioned earlier. The 2019 Section 475 election due date for individuals was April 15, 2019, and March 15, 2019, for existing partnerships and S-Corps.

Section 475 ordinary income is “qualified business income” (QBI). A TTS trader with 475 income net of business expenses is eligible for a 20% QBI deduction, providing the trader is under the taxable income thresholds for a “specified service business.” QBI excludes capital gains, interest, and dividend income.

Consider a new entity. Trading in an entity account might help avoid ongoing WS loss problems. The company is separate from the individual and IRA accounts for purposes of wash sales since it is a different taxpayer. The IRS is entitled to apply related party transaction rules (Section 267) if the entity purposely tries to avoid wash sales with the owner’s accounts. If the company qualifies for TTS, it can consider a Section 475 MTM election exempting it from wash sales (on TTS positions, not investment positions). A “new taxpayer” entity is entitled to elect Section 475 by internal resolution within 75 days of inception. That comes in handy after missing the 475-election deadline for individuals by April 15.

Trade accounting for securities is less complicated with a new entity since there are no opening-year manual entries for WS losses deferred from the prior year-end.

Trade Section 1256 contracts and other financial instruments that are not considered securities for tax purposes. Learn about Section 1256 contracts in my blog post: Trading Futures & Other Section 1256 Contracts Has Tax Advantages.

The following financial instruments are not securities or 1256 contracts: ETN prepaid forward contracts, cryptocurrencies, precious metals, forex, and swap contracts. Only securities are subject to wash sale loss adjustments.

GNM CPAs Darren Neuschwander, Christie Kam, and Amanda Smitson contributed to this blog post.

Learn more about wash sale loss rules in Green’s 2019 Trader Tax Guide.

Short Sellers Should Not Rely On Brokers For IRS Reporting (Recording)

September 19, 2016 | By: Robert A. Green, CPA

Traders are on their own when it comes to tax compliance for short sales. Brokers don’t report constructive sales on appreciated financial positions on 1099-Bs, and many miscategorize stock borrowing fees as interest expenses.

Join trader tax expert Robert A. Green, CPA as he explains complicated tax rules for short sale transactions and expenses:

– Short sales against the box.
– Constructive sales on appreciated positions.
– Special rules for short-term vs. long-term capital gains and losses.
– Using tax compliant software.
– Dividends and “payments in lieu” of dividends.
– Stock borrow fees vs. interest expenses.
– Investors face limitations on deductions.
– Traders with trader tax status & Section 475 bypass short sale problems.
– Tax compliance tips and examples.

Short Selling

| By: Robert A. Green, CPA

The essence of trading is buying and selling financial products for income. If you think the asset will rise in value, buy first and sell afterward — this is known as a “long position.” If you want to speculate on declining value, borrow the security to sell it first and then buy it later to close the short position — this is “selling short.” (There are other ways to speculate on market drops, like buying put options or inverse ETFs, both of which are long positions.)

There are two types of short sales: (1) a short sale and (2) a short sale against the box. Both involve borrowing securities from another account holder arranged by a broker…

STOCK BORROW FEES AND LOAN PREMIUMS

Short selling is not free; a trader needs a broker to arrange a stock loan. Brokers charge short sellers “stock borrow fees” or “loan premiums.” Tax research indicates these payments are “fees for the temporary use of property.” Watch out: Many brokers refer to stock borrow fees as “interest expense,” which confuses short sellers and their accountants.

Although it’s uncertain in the tax code, there might be a rationale for investors to deduct stock borrow fees as “other itemized deductions” on line 16 of Schedule A (itemized deductions). The code seems to include it, but Schedule A instructions do not. Consult a tax professional.

Stock borrow fees are business expenses when the taxpayer has TTS.

Stock borrow fees are not interest expenses, so investors can’t include them in those deductions.

Excerpt from Green’s Trader Tax Guide Chapter 16 Short Selling. 

Securities Brokers Don’t Tell The Full Story About Wash Sale Losses

January 20, 2016 | By: Robert A. Green, CPA

Click to read Green’s blog post on Forbes: Securities Brokers Don’t Tell The Full Story About Wash Sale Losses

It’s an inconvenient truth for brokers that the IRS asks them to report wash sale losses on 1099-Bs differently from the way traders must report wash sale adjustments on income tax returns. Brokers are correct in preparing 1099-Bs, but incorrect in telling clients they should import 1099-Bs into their income tax filings. […] Click here. 

 

 

barrons

Thanks @twcarey for covering this tax story in Barron’s (1/23/16) “Two New Mobile Investing Apps for Millennials,” Divy introduces investing as a social exercise while Clink emphasizes regular savings. Plus, tax advice. Click here for excerpt. 

 

Don’t Solely Rely On 1099-Bs For Wash Sale Loss Adjustments

January 5, 2016 | By: Robert A. Green, CPA

Click to read Green's blog post: Wash Sale Loss Adjustments Can Be A Big Tax Return Headache

Click to read Green’s blog post: Wash Sale Loss Adjustments Can Be A Big Tax Return Headache

Broker-issued Form 1099-Bs for securities provide cost-basis reporting information, but they don’t provide taxpayers everything they need for tax reporting if the taxpayer has multiple trading accounts or trades equities and equity options.

Brokers calculate wash sales based on identical positions (an exact symbol only) per separate brokerage account. But the wash sale loss rules for taxpayers, Section 1091, requires taxpayers to calculate wash sales based on substantially identical positions (between equities and equity options and equity options at different exercise dates) across all their individual accounts including IRAs — even Roth IRAs.

The best accounting solution for generating a correct and compliant Form 8949 is trade accounting software that’s compliant with Section 1091. Don’t just rely on a Form 1099-B (exception: if there is only one brokerage account, the trading is only in equities, not equity options and there are no cost-basis adjustments including wash sale losses).

Many tax preparers and taxpayers continue to disregard Section 1091 rules, even after acknowledging differences with broker 1099-B rules. They do so at their peril if caught by the IRS.

Securities accounting is challenging
Securities brokers are making advances in tax-compliance reporting. It’s due to Congressional legislation and implementation of IRS cost-basis reporting regulations for which phase-in commenced in 2011. Phase-in is almost complete: Equity option transactions and simple debt instruments acquired on January 1, 2014 or later were reported for the first time on 1099-Bs for tax year 2014. The only cost-basis reporting item remaining to be phased-in is reporting complex debt instruments starting on January 1, 2016 or later. Tax-year 2015 1099-Bs should be the same as in 2014.

Taxpayers report proceeds, cost basis, wash sale loss and other adjustments, holding period and capital gain or loss – short term vs. long-term (held over 12 months) on Form 8949. According to the form’s instructions, taxpayers without wash sale and other adjustments to cost-basis may simply enter totals from broker 1099-Bs directly on Schedule D and skip filing a Form 8949. After all, the IRS gets a copy of the 1099-B with all the details.

But this Form 8949 instruction leads many taxpayers and tax preparers astray with taxpayers thinking they don’t have wash sales when in fact they do have many to report in compliance with IRS wash sale rules for taxpayers, which differ from IRS rules for brokers.

Form 8949 problems: apples vs. oranges with 1099-Bs
In accordance with IRS rules for brokers, a 1099-B reports wash sales per that one brokerage account based on identical positions. The wash sale rules are different for taxpayers, who must calculate wash sales based on substantially identical positions across all their accounts including joint, spouse and IRAs. With different rules for brokers vs. taxpayers (apples vs. oranges), it’s expected that in many cases broker-issued 1099-Bs might report different wash sale losses than a taxpayer must report on Form 8949. A broker may report no wash sales when in fact a taxpayer may have many wash sale losses. A taxpayer may permanently lose a wash sale loss between a taxable and IRA account, but a broker will never report that on a 1099-B. In some cases, a broker can report a wash sale loss deferral at year-end, but the taxpayer may have absorbed the wash sale loss in another account, thereby eliminating this tax problem at year-end.

This problem of different rules on wash sales for brokers vs. taxpayers is still widely unknown by many taxpayers and tax preparers. Far too many continue to omit Form 8949 or file an incorrect Form 8949 relying solely on broker 1099-B reporting when they should be using securities trade accounting software to properly calculate and report wash sale loss adjustments.

A predicament for some tax preparers who do understand the problem is that calculating wash sales correctly leads to un-reconciled differences between Form 8949 and 1099-Bs. Some tax preparers don’t want to draw attention to those differences, fearing IRS notices generated from IRS 1099-B automated matching programs. It’s ironic that the mission of Congress in cost basis legislation was to “close the tax gap” providing more opportunities for matching 1099-Bs, but it may lead to a mess of un-reconciled differences. To better close the tax gap, Congress should realign broker and taxpayer wash sale rules to be the same.

There is one scenario where a taxpayer can solely rely on a 1099-B and skip filing Form 8949 by entering 1099-B amounts on Schedule D: when the taxpayer has only one brokerage account and trades equities only with no trading in equity options, which are substantially identical positions. Plus, the taxpayer must not have any wash sale loss or other adjustments. In that narrow case, there are apples vs. apples — only one account and substantially identical is the same as identical.

This problem of apples vs. oranges is biggest for individuals who tend to have multiple accounts. There is a solution for traders who qualify for TTS. Trade in an entity and elect Section 475 MTM, which is exempt from wash sale rules. Keep investment accounts with far less wash sale loss activity on the individual level.

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 require brokers to calculate and report wash sales per account based on identical positions (it’s reiterated in Form 1099-B instructions). Here is an example of broker rules: an account holder sells 1,000 shares of Apple stock for a loss and buys back 1,000 shares of Apple stock 30 days before or 30 days after. That’s a wash-sale loss deferred (added) to the replacement position cost-basis. But, if the account holder buys back Apple options instead of Apple stock, according to broker rules it’s not a wash sale because an option is not “identical” to the same company’s stock. Broker computer systems are programmed to calculate wash sales based on an identical symbol, and stock and options and options at different exercise dates have different symbols.

IRS regulations for Section 1091 require taxpayers to calculate wash sales based on “substantially identical” positions. That’s very different from the rule for brokers that require “identical” positions. This can be a big 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.

Don’t get into trouble with the IRS
Many traders and local tax preparers who are not that savvy to the wash sale rules may leap to import 1099-Bs into TurboTax or choose to enter totals directly on Schedule D, omitting Form 8949, but they will probably not comply with Section 1091. In effect, they are using broker rules and unknowingly or willfully disregarding Section 1091. While tax preparers may be covered for malpractice, they will have Circular 230 penalties and ignorance is not an acceptable excuse.

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 Green’s 2016 Trader Tax Guide Chapter 2.)

Accounting software and services for traders
When it comes to a trading activity, it’s wise to do separate accounting for trading gains and losses vs. expenses. A consumer off-the-shelf accounting program is fine for keeping track of expenses, non-trading income, home office deductions and itemized deductions. But when it comes to trade accounting for securities, these programs are inadequate — you need a specialized securities trade accounting program and/or accounting firm, or in limited cases brokerage firm reporting may be sufficient. On our Website accounting services page, learn more about trade accounting software. Choose our professional accounting service using this software.

Futures accounting isn’t required, as you can rely on the tightly controlled one-page 1099-B with summary reporting, using MTM reporting. Although spot forex accounting could be a nightmare if you try to do it yourself, you can rely on the broker’s annual tax reports and should use summary reporting. Spot forex is not a “covered security,” so there are no Form 1099-Bs.

Frequently Asked Questions (FAQs) On Trader Tax

February 19, 2015 | By: Robert A. Green, CPA

How are securities taxed?
Securities traders need to watch out for higher tax rates, wash sales, capital-loss limitations and accounting challenges. Realized transactions in securities are reported trade by trade (or line by line) on Form 8949, which feeds into Schedule D where short- and long-term capital gains rates apply. Click here to see what’s included in securities and to learn more. Visit the Tax Treatment section for tax guidance on all sorts of trading instruments.

How should I handle wash sales on securities?
See our separate FAQs on wash sale losses.

How are Section 1256 contracts taxed?
Section 1256 contract traders enjoy lower 60/40 tax rates, summary reporting, and no need for accounting. (The 60/40 rates mean 60% is taxed at the lower long-term capital gains rate and 40% is taxed at the short-term rate, which is the ordinary tax rate.) Section 1256 contracts are marked-to-market (MTM) on a daily basis and reported on Form 6781. MTM means you report both realized and unrealized gains and losses at year-end. Click here to see what’s included in Section 1256 contracts and to learn more.

What is Section 475 and can that election help me?
Section 475 MTM allows qualifying business traders to deduct trading losses in the current tax year as ordinary business losses, without capital loss limitations or wash sale loss adjustments. Short term capital gains are taxed at the ordinary rate, so taxes are the same on trading gains, but Section 475 is much better on trading losses — we call it “tax loss insurance.” GreenTraderTax recommends Section 475 for securities, but not for Section 1256 contracts where you would otherwise forgo lower 60/40 tax rates. Click here to learn more about Section 475.

Can you request a 1099B based on using Section 475?
Brokers are supposed to prepare Form 1099Bs for the everyman, not based on a taxpayer’s election or other facts and circumstances. How can a broker know for sure that a trader elected Section 475 on time and or is entitled to use Section 475, which is conditional on qualifying for trader tax status?

Can I deduct my trading-related expenses on my tax return?
Deductibility is based on tax status: whether you qualify for trader tax status (business treatment) or must use the default investor tax status (investment treatment).

Individual investors are permitted to deduct Section 212 investment expenses related to the production of investment income. Investment expenses exclude home-office, education, and Section 195 startup costs. There are many limitations for investment expenses, deductible as miscellaneous itemized deductions on Schedule A including the 2% AGI threshold, Pease limitation, listed property rules, and AMT preferences.

Business traders qualifying for trader tax status are able to deduct all trading expenses, including home office, education, and Section 195 startup costs, from gross income. Sole proprietor traders report business expenses (only) on Schedule C, and trading gains and losses are reported on other tax forms. An election is not required for claiming business expense treatment. Click here to learn how to qualify for trader tax status. Click here to learn more about business expense treatment.

Are brokerage commissions tax deductible?
Yes, but they are not separately stated tax deductions. Rather, commissions are part of your trading gain or loss — an adjustment to proceeds and cost-basis.

Do I need to fill out a Form 8949 for my securities trades?
Casual investors might have no wash sale adjustments or other cost-basis adjustments and just one securities brokerage account with a few equity transactions. They may qualify to attach their 1099B and skip inclusion of a Form 8949. Active traders won’t qualify for this short cut.

The cost-basis rules are almost fully phased in. Options and less complex fixed income securities acquired on Jan. 1, 2014 or later are reportable for the first time on Form 1099-Bs for 2014. Click here to learn more about IRS cost-basis reporting and Form 8949.

Where can I learn more about trader tax matters, including entities, retirement plans, Obamacare taxes, compliance tips, and more?
In Green’s 2015 Trader Tax Guide.

I prepared these FAQs for an online broker catering to active securities traders. 

 

Frequently Asked Questions (FAQs) On Wash Sale Losses

| By: Robert A. Green, CPA

Wash sale losses are a major source of confusion for taxpayers and brokers come tax time, so we answered several FAQs to help.

What’s the best solution for reporting wash sale losses correctly?
Trader tax accounting software that downloads all purchase and sale transaction history and calculates wash sale losses according to taxpayer rules recapped below. In most cases, taxpayers can’t solely rely on 1099Bs or broker profit and loss reports for reporting wash sales. GreenTraderTax recommends software to calculate wash sales across all your accounts and for generating a correct Form 8949. You need to reconcile Form 8949 to 1099Bs and explain the differences as best you can. Click here to learn about GreenTraderTax’s accounting service for securities traders.

What are wash sale losses?
Per IRS Pub. 550, “A wash sale occurs when you 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.”

The IRS wash sale loss rules (Section 1091) are written to protect the U.S. Treasury against taxpayers taking “tax losses” at year-end to lower tax bills while they get right back into the same positions. The IRS views that as a tax loss but not an economic loss and much of the tax code prevents that from happening.

Wash sale loss adjustments defer losses to the subsequent tax year, where a taxpayer hopefully can utilize that loss. However, if you trigger a wash sale loss with an IRA, you permanently lose the wash sale loss.

Do I have to account for wash sale losses?
Yes, if you trade securities including equities, equity options, ETFs, narrow-based indices (made up of nine or fewer securities), and bonds. Click here to learn more about securities.

What’s exempt from wash sale losses?
Wash sales do not apply to Section 1256 contracts including futures, broad-based indices, and options on futures since they are marked-to-market (MTM). That’s economic reporting and there’s no way to defer wash sale losses. Click here to learn more about Section 1256 contracts.

Business traders with a Section 475 MTM election are exempt from wash sale loss reporting on their business trading positions. Consider a timely 2015 Section 475 election to convert 2014 wash sale loss deferrals on business positions into ordinary losses on Jan. 1, 2015. Click here to learn more about Section 475. Existing individuals and partnerships must file a Section 475 election by April 15 and S-Corps by March 15.

Where do I report wash sale loss adjustments?
Report wash sale loss adjustments on Form 8949 (instructions), along with other cost-basis reporting. Learn more about cost-basis reporting in the Green Trader Tax Center.

Do brokers report wash sale loss adjustments on Form 1099B?
Yes, but in compliance with IRS rules for brokers which differ from IRS rules for taxpayers. In most cases, taxpayers need to do additional work on wash sale loss reporting.

How do broker and taxpayer rules differ on wash sales?
Brokers calculate wash sales based on identical positions (an exact symbol only) per brokerage account. Section 1091 requires taxpayers to calculate wash sales based on substantially identical positions (between stocks and options and options at different exercise dates) across all their accounts including IRAs — even Roth IRAs.

What is a substantially identical position?
Apple stock and Apple options are substantially identical, but Apple stock and Google stock are not substantially identical.

Are options subject to cost-basis reporting and wash sale loss adjustments?
Yes, IRS cost-basis reporting rules phased-in options purchased on or after Jan. 1, 2014. Brokers won’t report a wash sale loss between a stock and an option, but taxpayers must do so. Options at different expiration dates have different symbols, so they are considered substantially identical.

Can I rely on my 1099-B for reporting wash sale loss adjustments?
Only if you have one brokerage account trading equities. If you trade stocks and stock options, or just stock options and/or have multiple brokerage accounts, you can’t rely on brokerage firm Form 1099-Bs for reporting wash sale losses correctly because there will be differences in application of taxpayer rules on substantially identical positions.

Are brokerage firm profit and loss reports similar to 1099Bs?
Yes, brokers use the same accounting for the 1099B and their profit and loss reports. When brokers suggest downloading a 1099B into TurboTax, they really mean downloading their profit and loss report. Those P&L reports account for wash sales based on broker rules, not taxpayer rules.

Do I have to worry about my IRA accounts in my wash sale loss calculations?
Yes, as recapped in IRS Pub. 550 above, Section 1091 includes all types of IRAs. It’s a catastrophic mistake to trigger a wash sale loss in your IRA since you will never get that tax loss benefit as it won’t reduce distributions in retirement for a traditional IRA. It’s wise to avoid trading substantially identical positions between an IRA and your taxable accounts.

What accounts are included in the wash sale loss analysis?
It goes by taxpayer identification number. If you are married filing joint, make sure to include each spouse’s separate, joint, and IRA accounts.

Are entity accounts included in the wash sale loss analysis?
Maybe. Although Section 1091 rules do not include your entity accounts, Section 267 related party rules can drag your entities into the wash sale loss analysis. Case law can apply Section 267 related party transaction rules in the event a trader plans to avoid a wash sale loss between his entity and individual accounts. If the related party transaction “is purely coincidental and is not prearranged” Section 267 law does not apply. If Section 267 applies it can lead to wash sale loss deferral or losing the wash sale loss permanently. 

Where can I learn more about wash sales?
Read the GreenTraderTax blog “How will you handle wash sale losses on securities this tax season?” and watch the related Webinar recording.

I prepared these FAQs for an online broker catering to active securities traders. 

Wash Sale Losses

February 11, 2015 | By: Robert A. Green, CPA

THE BIG PICTURE ON WASH SALE LOSSES

Day and swing traders inevitably trigger many wash-sale (WS) loss adjustments amounting to tens or hundreds of thousands of dollars. This occurs when you take a loss on a security and repurchase it within 30 days (after or before).

 A WS reduces the cost basis on the position sold and adds the loss to the replacement position’s cost basis. That defers the WS loss, creating phantom taxable income and capital gains taxes.

It’s okay to incur WS losses during the year but try to avoid delaying the WS losses to the following year. Deferring a loss from November to December is acceptable; however, postponing a loss from December 2022 to January 2023 is not.

Learn how to “break the WS chain” at year-end. For example, sell your entire position in security A by Dec. 20, 2022, and don’t repurchase it for 30 days, around Jan. 21, 2023. That doesn’t provide a WS bridge from the tax year 2022 to 2023. You may deduct the whole year of WS losses in 2022.

When you get your broker-issued Form 1099-B showing massive WS loss adjustments, don’t panic. What’s critical is the number of WS open at year-end for which you repurchased positions within 30 days in January 2023. For example, suppose the WS loss adjustments column on the 1099-B is $500,000. If you avoided all WS at year-end by refraining from repurchases in January, the cost basis column should be $500,000 greater than your actual purchase price.

The 1099-B calculates taxable income as follows: Proceeds, minus cost basis, plus WS loss adjustments equals net taxable capital gain or loss.

There’s a quirky WS rule between taxable and IRA accounts. The WS loss becomes permanent if you take a loss in a taxable account and repurchase the security position within 30 days in an IRA. The IRS does not allow you to add the WS loss adjustment to the IRA cost basis. Yet, the IRS requires a reduction of the cost basis in the taxable account. Avoid this problem with a “do not invest list” in the IRAs vs. what you trade and invest in taxable accounts. This WS rule applies to taxable vs. IRA accounts; an IRA account is not subject to WS losses.

For more information, see Green’sTrader Tax Guide Chapter 4 Accounting for Trading Gains & Losses.

How Will You Handle Wash Sale Losses On Securities This Tax Season?

January 23, 2015 | By: Robert A. Green, CPA

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If you actively trade equities and equity options and or securities in more than one account, unless you use proper software on all your individual taxable and IRA accounts, you will probably handle wash sales wrong and under-report or over-report your taxable income. In these cases, you can’t solely rely on 1099-B reporting because brokers use a different set of tax compliance rules than taxpayers in calculating and reporting wash sale losses.

The IRS cost-basis reporting saga continues
Accounting for trading gains and losses is the responsibility of securities traders; they must report each securities trade and related wash-sale adjustments on IRS Form 8949 in compliance with Section 1091, which then feeds into Schedule D (capital gains and losses). Form 8949 came about after the IRS beefed up compliance for securities brokers starting in 2011, causing headaches, confusion and additional tax compliance cost. Congress found tax reporting for securities to be inadequate and thought many taxpayers were underreporting capital gains. The cost-basis rules are almost fully phased-in. Options and less complex fixed income securities acquired on Jan. 1, 2014 or later are reportable for the first time on Form 1099-Bs for 2014. Inclusion of complex debt instruments on 1099-Bs is delayed until Jan. 1, 2016.

Broker-issued securities Form 1099-Bs provide cost-basis reporting information, but they often don’t provide taxpayers what they need for tax reporting. For example, brokers calculate wash sales based on identical positions (an exact symbol only) per separate brokerage account. But Section 1091 requires taxpayers to calculate wash sales based on substantially identical positions (between stocks and options and options at different exercise dates) across all their accounts including IRAs — even Roth IRAs.

Taxpayers report securities proceeds, cost basis, adjustments, holding period and capital gain or loss – short term vs. long-term (held over 12 months) on Form 8949. According to the form’s instructions, taxpayers without wash sale and other adjustments to cost-basis may simply enter totals from broker 1099-Bs directly on Schedule D and skip filing a Form 8949. After all, the IRS gets a copy of the 1099-B with all the details.

But, there is a protracted ongoing problem for many taxpayers with securities sales. For 2014 tax reporting, many 1099-Bs may not report wash sales or other cost-basis adjustments leading taxpayers or their tax preparers to choose the short-cut option: to enter totals on Schedule D and omit the headache of preparing a Form 8949. But, we know very well that taxpayers are supposed to calculate wash sales differently from brokers, and there could be wash-sale adjustments that taxpayers should make on Form 8949, which probably changes the net capital gain or loss amount.

Section 1091 wash sale loss rules for taxpayers
Per IRS Publication 550: A wash sale occurs when you 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.

An example of how wash-sale rules differ between brokers and taxpayers
IRS regulations require brokers to calculate and report wash sales per account based on identical positions (it’s reiterated in Form 1099-B instructions). Here is an example of broker rules: an account holder sells 1,000 shares of Apple stock for a loss and buys back 1,000 shares of Apple stock 30 days before or 30 days after in that same account. According to the 1099-B, that’s a wash-sale loss deferred (added) to the replacement position cost-basis. But, if the account holder buys back Apple options instead of Apple stock, according to broker rules it’s not a wash sale because an option is not “identical” to the same company’s stock – however the taxpayer must report it as a wash sale. Broker computer systems are programmed to calculate wash sales based on an identical symbol, and stock and options and options at different exercise dates have different symbols. In that same example, if the taxpayer bought back Apple stock in a separate account, including an IRA, the broker would not treat it as a wash sale, but according to Section 1091, the taxpayer must treat it as a wash sale.

Don’t assume that substantially identical positions are worse for wash-sale calculations; they could actually be better. Subsequent transactions with profit can absorb prior wash sales before year-end, which can fix a wash-sale problem. So a gain on an option can absorb a wash-sale loss on a stock. Note that Apple stock and Apple options are substantially identical, but Apple stock and Google stock are not substantially identical.

Ways to avoid Form 8949
Business traders qualifying for trader tax status are entitled to elect Section 475 mark-to-market (MTM) accounting elected on a timely basis. 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 (and Section 475 trades are exempt from wash sale rules), it does not change their requirement for line-by-line reporting on Form 4797.

Form 8275-R disclosure
If you or your local tax preparer decide to cut corners and disregard Section 1091 taxpayer rules for calculating wash sales across all accounts based on substantially identical positions — choosing instead to rely on broker 1099-B reporting in spite of known broader wash-sale conditions (explained in Chapter 4) — then you need to “disclose items or positions that are contrary to Treasury regulations” on Form 8275-R included with your tax return filing. We asked a leading malpractice-insurance carrier for tax preparers about this issue and they said, “there is coverage for regulatory inquiries but not if the firm is investigated for preparer penalties.” Whether you knowingly or ignorantly cut corners relying on 1099-Bs for active securities traders, it’s a circular 230 infraction and ignorance is not an excuse. Use our guides and suggestions to do it right.

Software for wash sales
When you consider a securities trade accounting software and Web-based solution, ask the vendor if they calculate wash sales based on Section 1091 and if not, you may want to skip that solution.

TurboTax ads say they make taxes simple and they imply you can just import your 1099-B. You’ll spend a lot of time finding their small fine print about having to make Section 1091 adjustments on your own.

Don’t tackle this minefield on your own, get professional help
Every case is different and our CPAs will look for ways to work with what you provide us, and in some cases, we can make manual adjustments. For example, if you don’t have open wash sales at year-end, we may be able to find ways to generate proper tax forms using 1099Bs, broker tax reports, and software solutions that you provided to us. Green NFH also offers a securities trade accounting service using proper software to be fully compliant with Section 1091.

We used several excerpts from Green’s 2015 Trader Tax Guide for this blog. 

Traders Expo NYC: Trader Tax Law Update

January 22, 2015 | By: Robert A. Green, CPA

David GrandeyJoin me at The Traders Expo New York, February 28–March 2,
to learn the latest strategies for trading stocks, ETFs, commodities, futures & forex, watch pros explain live trades, test drive cutting-edge products, and receive exclusive discounts & prize giveaways! Please see my speaking schedule below and register free now.

Trader Tax Law Update: Current Developments, Obamacare Taxes, Trader Tax Status, Key Tax Elections, Entities, and Retirement Plans
March 1, 8:00 am – 9:00 am EST

This presentation will cover:

  • Current developments including tax reform, tax changes, and court cases.
  • Obamacare taxes: individual health insurance mandate (tax penalties, exemptions, premium tax credits, and claw backs of subsidies) and the net investment income tax on upper-income taxpayers.
  • How to save thousands with trader tax status (business treatment) and discover key trader tax strategies and tax elections. Investors have important elections to make, too.
  • Tips for preparing a trader tax return for 2014 with maximum tax benefits.
  • The key tax treatment differences between securities, Section 1256 contracts (futures, all types of options, ETFs, forex, precious metals, and more).
  • The best types of entities and retirement plans for traders.

There is no recording of this live event.