With tax season nearing, you’re probably searching for ways to reduce your taxes. In doing so, you’ll come across the wash-sale rule. In today’s post, we’ll take a closer look at the wash-sale rule and how a wash-sale can be used for tax planning purposes.
What is the wash-sale?
A wash sale is when you sell an investment and repurchase it or a similar asset, commonly at a similar price. It’s a “wash” in terms of investing because the sale and repurchase have no real influence on the performance or composition of your portfolio.
You might be thinking, why bother if it has no effect on your investment portfolio? Simple: to claim a loss to reduce taxable income.
The U.S. tax code allows you to sell an investment at a loss and lower your taxable income if it turns out to be a losing proposition. However, it’s important not to make a subsequent purchase of the same security (or one that is substantially similar) too soon to avoid violating the wash-sale rule.
What is the wash-sale rule?
The wash sale rule forbids an investor from claiming a tax deduction if they sell an investment at a loss then buy it back again within 30 days of the sale, or if the investments are substantially equivalent.
However, taxpayers should keep in mind that including the day you sell the investment, it actually takes 61 days that you, as well as your spouse or a corporation you own, cannot acquire the same or similar investment. Otherwise, the IRS will view the purchase or investment as a wash sale. As a result, you can’t recover any of the losses incurred.
What happens if you violate the wash-sale rule?
Fortunately, there isn’t any real penalty. However, your attempt to claim a loss as a tax deduction will be rejected if your transaction is in violation of the wash-sale rule. Furthermore, the purchase price of the security you acquired that broke the wash-sale rule must be increased by the amount of the loss. This delays the loss deduction until the security is sold, according to the IRS.
Want to learn more about the wash-sale rule? Work with our CPA.
A wash-sale is just one of the ways you can reduce your taxable income. However, it must be done correctly for it to be a viable tax planning strategy. Our CPA can walk you through the process and help you with effective tax preparation. Get in touch with us or book a consultation to get started.
