7 Wash Sale Facts You Should Know Before Selling Stocks to Harvest Tax Losses
Are you optimistic about stock markets in 2023? If so, you may be considering year-end strategies to prepare for more promising investment horizons. For example, after the stock market decline of 2022, you can now hold securities – whether stocks, ETFs or mutual funds – that would incur capital losses if sold. These losses could then be used to offset capital gains and a limited amount of ordinary income. Called “reaping” capital losses, this is a popular year-end strategy. But beware: IRS rules on wash sales can ruin your tax planning.
The “fictitious sale” problem
In short, the tax rules allow you to offset capital losses against capital gains on Schedule D of your Form 1040 tax return. Any unused capital losses can then be deducted against up to $3,000 of ordinary income. Finally, you can carry forward the remaining losses to the next tax year. If you think stocks will rise in 2023, you might think it makes fiscal sense to sell the losses now, before the end of 2022, and buy back those stocks in January 2023 to keep your investment in them.
That’s where this nifty tax plan runs into trouble. A sale of shares at a loss coupled with the redemption of the same shares within 30 calendar days of the sale will trigger the washing rules, refusing, for the moment, the capital loss. Below are the key facts to understand about these rules.
Beware of Wash Sales: Seven Things to Know
1. Unauthorized loss is not “lost” (with one major exception: see point 4 below). Instead, the loss that you cannot claim on your next Form 1040 tax return is added to the base and holding period of the replacement stock. If you buy fewer shares than you sold, wash sale treatment applies only to that number of shares (i.e. not the total number of shares originally sold).
2. While the lead time for wash sales is often advertised as a 30 day window, it is actually a 61 day window covering the 30 days before and after your sale, whether this period extends over two years or not. Buying in early January the same shares that you sold at a loss in late December would certainly be considered a wash sale.
3. The rules are triggered when you buy”substantially identical titlesbefore or after the loss. Let’s say you sell the shares of the company you work for at a loss, but you strongly believe that its price will rebound. You’re stuck with the wash sale deadlines once you’ve sold it, and you also have to follow the insider trading rules even before you do. Instead, you can buy the shares of another company in the same industry or of a mutual fund or ETF that tracks that industry.
4. The wash sale rules do not apply directly when the sale and purchase both occur in your 401(k) or IRA, as capital gains and losses are not tracked in these accounts. However, after the sale in your retail brokerage account, you cannot trick the IRS into buying the same security in your IRA or 401(k) instead. IRS Income Tax Ruling 2008-5 goes even further: it prevents you from adding this loss to the basis of the shares purchased in your IRA. This would permanently eliminate the denied capital loss in the year of the sale.
5. Professions involving options listed, employee stock option exercises and stock purchased under employee stock purchase plans (ESPPs) may trigger the wash sale when they occur within 30 days of the sale of the stock at a loss. The treatment for incentive stock options (ISO) is even more drastic because a fictitious sell loss is triggered even when you sell ISO stock at a price above the strike price but below the market price on the date of exercise. For restricted stock or restricted stock units, the award itself or its acquisition may also trigger the wash sale rules when you have sold shares at a loss, as explained in a myStockOptions.com FAQsan online educational resource on equity compensation.
6. Your brokerage firm will track and report wash sales by account. This may not be the case for the various accounts you (and your spouse) have at the firm and at other brokers. Accordingly, you and/or your tax preparer must account for securities trading activity in all accounts you hold.
seven. Form 1099-B, which you receive from your broker in time for tax season (usually before Feb. 15), reports all your stock sales from the previous year. It indicates (in box 1g) the amount of any non-deductible loss resulting from a wash sale involving covered securities (at least for those in the same account). Note that many brokerage firms reformat Form 1099-B into their own replacement statement that has columns labeled the same as the boxes on the IRS form. You must still declare the fictitious sale on your tax return on form 8949even if the loss on those shares will not be recognized immediately, and adjust the tax base on the replacement shares when you sell them.
More tax resources
See IRS Publication 550 for IRS advice on wash sales. It appears in the “Capital gains and losses” subsection of Chapter 4 (pages 56-57 in the version for 2021 tax returns).
When your tax planning (and tax filing) for 2022 involves income from the sale of company stock and/or equity compensation, such as stock options, restricted stock units or ESPPs, you may want to explore the Tax Center at myStockOptions.com. It contains articles, FAQs, videos, and annotated IRS forms that demystify complex federal tax rules. On December 1, myStockOptions.com is also hosting a online seminar on year-end and beginning-of-year financial planning and tax strategies for comp equity.