Surprise! Your stock loss is not deductible.
You may be considering booking stock losses due to recent market drops in order to save on your bill from Uncle Sam. Selling losers can be a great strategy when these losses can offset stock gains and up to $3,000 in excess stock losses can offset your ordinary income. However, there is a little known rule called the wash sale rule that could surprise the unwary taxpayer.
If the wash sale rule applies, you cannot report a loss you take when you sell a security. Per the IRS,
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:
Why the rule?
Many investors were selling stock they liked simply to book the loss for tax reasons. They then turned around and immediately re-purchased shares of the same company or mutual fund. If done repeatedly, shareholders could constantly be booking short-term losses on a desired company while still owning the shares in a chosen company’s stock indefinitely. Clever shareholders would even purchase the replacement shares prior to selling other shares in the same company to book the loss.
How does one take action to ensure the wash sales rule works to your advantage?
If your loss is ever disallowed because of the wash sale rule you can add the disallowed loss on to the cost of the new security. When the security is eventually sold in the future, the previously-forfeited loss will be part of the calculation of future gain or loss. This also includes the original stock's holding period to help define the transaction as a short-term or long-term sale.
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