New Wrinkles for Wash Sale Rule
Tax planning for securities is especially tricky this year. Barring any legislative action, tax rates are scheduled to increase in 2013. Nevertheless, if your circumstances dictate it, you may want to preserve a loss from a securities sale in 2012. That means you must pay close attention to the “wash sale” rule as the year begins to wind down.
How it works: Normally, you can use capital losses to offset your capital gains, plus up to $3,000 of ordinary income. However, under the wash sale rule, you are not permitted to deduct a loss from the sale of securities if you buy “substantially identical” securities within 30 days of the sale. So you get no tax benefit from the loss on your 2012 return. It doesn’t matter if the purchase takes place before or after the date of the sale.
When are securities considered to be substantially identical? One example is shares of common stock in the same corporation. On the other hand, bonds issued by different obligors are not considered to be substantially identical. Whether the wash sale rule affects bonds from the same issuer depends on a number of factors such as interest rates, face amounts, issue dates, maturity dates, etc.
Be aware that there is a way you can realize a current loss under the wash sale rule without waiting 31 days to repurchase the stock. This strategy commonly is referred to as “doubling up.”
Example: You bought 100 shares of High-Tech Corporation stock at $50 a share and now it is selling at $40 a share. But you believe the price of the stock is about to rebound. Instead of selling the original block of shares, which would produce a $1,000 loss, you double up by buying 100 more shares of High-Tech stock at $40. Then you wait more than 30 days and sell the first 100 shares at $42.
Result: By doubling up, you have a deductible loss of $800. What’s more, you now hold shares in High-Tech with a basis of $40. If you decide to sell the shares at $42, you will realize a capital gain of $200. Capital gains in 2012 are taxed more favorably than they will be in 2013.
If you had simply sold the initial shares at $42 and reacquired the new shares without waiting more than 30 days, you would not be able to deduct your $800 loss.
At least there is a silver lining if you are forced to forfeit a tax loss due to the wash sale rule. The amount of the loss is added to your basis in the new stock. Thus, when you sell the new stock in the future, a smaller amount of gain will be subject to tax. If the stock is sold at a loss, you can deduct a larger amount as a loss.
Final points: Remember that the tax law is subject to change. Also, consider all the relevant economic ramifications—not just taxes—in your investment decisions.