Investors looking to realize capital losses at the end of the year need to be made aware of the Wash Sale Deferral Rules under I.R.C. 1091. Disposing of a stock or security at a loss and then within the 61-day time frame (30 days before + trade date + 30 days after) acquiring (or enters into a contract/option to acquire) substantially identical stock or security will create a Wash Sale deferral.
Two examples of what substantially identical can look like, selling a stock for a loss and acquiring the same stock or selling a stock for a loss and entering into a call option. Most brokerage firms will automatically calculate the wash sale deferral on your 1099B and 8949 statement provided to you when the year-end tax statements are made available, sometime in early February.
Wash sales are calculated on a First In, First Out Basis, the repurchased shares can only be used once and the loss deferral is then rolled into the basis of the newly acquired stock or securities.
When a wash sale has been triggered, there could be a potential character shift between short-term and long-term holding periods. This is dependent on the stock or security repurchased and the holding period of the newly acquired stock or securities.
With a long positioned stock or securities, the original holding period of the washed securities will continue to tack on days. There are other rules regarding holding periods with regards to short positioned stock or securities that are beyond the scope of the article. The taxpayer has the burden of proving no substantially identical acquisition, or contract to reacquire was entered into within the 61day window.
There are many planning opportunities when it comes to the wash sale rules. Planning around avoidance of the wash sale rules by allowing the loss in the current year or nonavoidance to defer losses to a later year where tax rates could be higher.
Christopher Williams is a partner with Kram, McCarthy, Ayers & Frost with over 10 years of experience in public accounting, specializing in financial services. His clients include high net worth individuals, investment companies, hedge funds, private equity funds, general partnerships, and management companies. He can be reached at 410-643-4477 or firstname.lastname@example.org.