Holding Period
The IRS classifies capital gains and losses on stock transactions as either long-term or short-term, depending on the length of time you owned the stock prior to the sale. If you owned your stock for one year or less prior to the sale, your gain or loss is short-term. A sales transaction for stock you have held for more than one year will result in a long-term capital gain or loss.
Your anticipated tax loss is disallowed if, within the period beginning 30 days before the date of the loss sale and ending 30 days after that date, you acquire “substantially identical” stocks or securities. For purposes of this article, let’s call them replacement securities.
According to the tax law, your loss transaction and the purchase of the replacement securities are a “wash,” so you shouldn’t be allowed any tax benefits. Please understand, however, that this righteous concept applies only to losses. If you sell for a gain and buy back identical stocks or securities within the above time frame, Uncle Sam is happy to collect his due with no qualms. (Among us tax professionals, this is known as a “heads I win; tails you lose” rule.)
But for the wash sale rules to come into play, the stocks or securities must truly be substantially identical. Stocks or securities issued by one corporation are not considered substantially identical to stocks or securities of another.
What about replacing one S&P 500 index mutual fund with another? Unfortunately, the IRS begs the question by saying only that all circumstances must be considered in evaluating whether stocks or securities are substantially identical. What the heck does that mean? Nobody knows. In my opinion, no mutual fund is substantially identical to another. That said, you should be wary of selling, for example, one S&P 500 index fund for a loss and then buying into another S&P 500 index fund within 30 days.
Also, don’t think you can have your spouse buy identical replacement securities without running afoul of the wash sale rules. Your tax loss is still disallowed. Ditto if your controlled corporation or IRA makes the buy, according to the IRS.
Example 1: Say you purchased 100 shares of XYZ Co. on Dec. 1, 2016, for $2,000. On April 1, 2017, you sell the shares for $1,200, thus incurring an $800 short-term loss. But on April 10, 2017, you have a change of heart and buy back 100 shares for $1,300. Your $800 loss is disallowed, but it gets added to the basis of the replacement shares. So your basis becomes $2,100 ($1,300 plus the $800 disallowed loss). In addition, the holding period for the replacement shares includes the Dec. 2, 2016, through April 1, 2017, holding period of the shares for which the loss was disallowed. When you file your 2017 return, report the wash sale on Part I of Form 8949, which feeds into Schedule D, since it was a short-term transaction (See the Schedule D instructions for full details on reporting wash sales).
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