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Wash Sale

 
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Category : > Income Tax Filing Across The USA
Posted On : Thu Jun 10th,2010

 
 

What do you mean by Wash Sale?

Wash sale refers a trading activity to sale a security (stock, bonds, options) at a loss and repurchasing the same or substantially identical stock soon afterwards. The subsequent purchase could occur within 30 days before or after the security is sold, creating a 30 days bracket that must be monitored to identify wash sales.

How can I identify Wash sale?

You cannot deduct losses from sales or trades of stock or securities in a wash sale.
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: 

1.    Buy substantially identical stock or securities,
2.    Acquire substantially identical stock or securities in a fully taxable trade,
3.    Acquire a contract or option to buy substantially identical stock or securities, or
4.    Acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA.

If you sell stock and your spouse or a corporation you control buys substantially identical stock, you also have a wash sale.

If your loss was disallowed because of the wash sale rules, add the disallowed loss to the cost of the new stock or securities. The result is your basis in the new stock or securities. This adjustment postpones the loss deduction until the disposition of the new stock or securities. Your holding period for the new stock or securities begins on the same day as the holding period of the stock or securities sold.

Example 1.    
Say for instance, you buy 100 shares of GOOG stock for $1,000. You sell these shares for $750 and within 30 days from the sale you buy 100 shares of the same stock for $800. Because you bought substantially identical stock, you cannot deduct your loss of $250 on the sale. However, you add the disallowed loss of $250 to the cost of the new stock, $800, to obtain your basis in the new stock, which is $1,050.

Example 2.
You are an employee of a corporation that has an incentive pay plan. Under this plan, you are given 10 shares of the corporation's stock as a bonus award. You include the fair market value of the stock in your gross income as additional pay. You later sell these shares at a loss. If you receive another bonus award of substantially identical stock within 30 days of the sale, you cannot deduct your loss on the sale. 

How can I figure out substantially identical stock or securities?

In determining whether stock or securities are substantially identical, you must consider all the facts and circumstances in your particular case. Ordinarily, stocks or securities of one corporation are not considered substantially identical to stocks or securities of another corporation. However, they may be substantially identical in some cases. For example, in a reorganization, the stocks and securities of the predecessor and successor corporations may be substantially identical. 

Can bonds or preferred stock be substantially identical?

According to the Internal Revenue Services IRS, bonds or preferred stock of a corporation are not ordinarily considered substantially identical to the common stock of the same corporation. However, where the bonds or preferred stock are convertible into common stock of the same corporation, the relative values, price changes, and other circumstances may make these bonds or preferred stock and the common stock substantially identical. For example, preferred stock is substantially identical to the common stock if the preferred stock: 

·    Is convertible into common stock,
·    Has the same voting rights as the common stock,
·    Is subject to the same dividend restrictions,
·    Trades at prices that do not vary significantly from the conversion ratio, and
·    Is unrestricted as to convertibility.


Do Wash Sale rules apply to options and future contracts?

Options and futures contracts: The wash sale rules apply to losses from sales or trades of contracts and options to acquire or sell stock or securities. They do not apply to losses from sales or trades of commodity futures contracts and foreign currencies. See Coordination of Loss Deferral Rules and Wash Sale Rules under Straddles, later, for information about the tax treatment of losses on the disposition of positions in a straddle. 

Securities futures contract to sell.   Losses from the sale, exchange, or termination of a securities futures contract to sell generally are treated in the same manner as losses from the closing of a short sale, discussed later in this section under Short sales . 

Warrants.   The wash sale rules apply if you sell common stock at a loss and, at the same time, buy warrants for common stock of the same corporation. But if you sell warrants at a loss and, at the same time, buy common stock in the same corporation, the wash sale rules apply only if the warrants and stock are considered substantially identical, as discussed next. 

What if I bought less stock than I sold and vise versa?

IRS define it as, If the number of shares of substantially identical stock or securities you buy within 30 days before or after the sale is either more or less than the number of shares you sold, you must determine the particular shares to which the wash sale rules apply. You do this by matching the shares bought with an equal number of the shares sold. Match the shares bought in the same order that you bought them, beginning with the first shares bought. The shares or securities so matched are subject to the wash sale rules.

Example 1.
You bought 100 shares of M stock on September 20, 2008, for $5,000. On December 15, 2008, you bought 50 shares of substantially identical stock for $2,750. On December 22, 2007, you bought 25 shares of substantially identical stock for $1,125. On January 4, 2008, you sold for $4,000 the 100 shares you bought in September. You have a $1,000 loss on the sale. However, because you bought 75 shares of substantially identical stock within 30 days before the sale, you cannot deduct the loss ($750) on 75 shares. You can deduct the loss ($250) on the other 25 shares. The basis of the 50 shares bought on December 15, 2007, is increased by two-thirds (50 ÷ 75) of the $750 disallowed loss. The new basis of those shares is $3,250 ($2,750 + $500). The basis of the 25 shares bought on December 22, 2007, is increased by the rest of the loss to $1,375 ($1,125 + $250).

Example 2.
You bought 100 shares of M stock on September 24, 2007. On February 3, 2008, you sold those shares at a $1,000 loss. On each of the 4 days from February 11-14, 2008, you bought 50 shares of substantially identical stock. You cannot deduct your $1,000 loss. You must add half the disallowed loss ($500) to the basis of the 50 shares bought on February 11. Add the other half ($500) to the basis of the shares bought on February 12. 

Loss and gain on same day.   Loss from a wash sale of one block of stock or securities cannot be used to reduce any gains on identical blocks sold the same day.

Example.
During 2003, you bought 100 shares of X stock on each of three occasions. You paid $158 a share for the first block of 100 shares, $100 a share for the second block, and $95 a share for the third block. On December 23, 2008, you sold 300 shares of X stock for $125 a share. On January 6, 2009, you bought 250 shares of identical X stock. You cannot deduct the loss of $33 a share on the first block because within 30 days after the date of sale you bought 250 identical shares of X stock. In addition, you cannot reduce the gain realized on the sale of the second and third blocks of stock by this loss. 

Do wash sale rules apply to the dealers in stock?

The wash sale rules do not apply to a dealer in stock or securities if the loss is from a transaction made in the ordinary course of business. 

Short sales.   The wash sale rules apply to a loss realized on a short sale if you sell, or enter into another short sale of, substantially identical stock or securities within a period beginning 30 days before the date the short sale is complete and ending 30 days after that date. 

For purposes of the wash sale rules, a short sale is considered complete on the date the short sale is entered into, if:

·    On that date, you own stock or securities identical to those sold short (or by that date you enter into a contract or option to acquire that stock or those securities), and 
·    You later deliver the stock or securities to close the short sale.

Otherwise, a short sale is not considered complete until the property is delivered to close the sale. 
This treatment also applies to losses from the sale, exchange, or termination of a securities futures contract to sell. 

Example.
On June 2, you buy 100 shares of stock for $1,000. You sell short 100 shares of the stock for $750 on October 6. On October 7, you buy 100 shares of the same stock for $750. You close the short sale on November 17 by delivering the shares bought on June 2. You cannot deduct the $250 loss ($1,000 − $750) because the date of entering into the short sale (October 6) is considered the date the sale is complete for wash sale purposes and you bought substantially identical stock within 30 days from that date.

Residual interests in a REMIC The wash sale rules generally will apply to the sale of your residual interest in a real estate mortgage investment conduit (REMIC) if, during the period beginning 6 months before the sale of the interest and ending 6 months after that sale, you acquire any residual interest in any REMIC or any interest in a taxable mortgage pool that is comparable to a residual interest.

How and where should I report Wash Sale?

Report a wash sale or trade on line 1 or line 8 of Schedule D (Form 1040), whichever is appropriate. Show the full amount of the loss in parentheses in column (f). On the next line, enter “Wash Sale” in column (a) and the amount of the loss not allowed as a positive amount in column (f). 

Wash trade

The United States Security and Exchange Commission define a wash trade as "a securities transaction which involves no change in the beneficial ownership of the security”.

It is an illegal act in which an investor manipulates stock transactions. Say for instance, he buys and sells the same security simultaneously in order to artificially increase trading volume and thus the stock price.

For example, an investor might simultaneously buy and sell shares in one company through two different brokerage firms in order to create the appearance of substantial trading activity that will draw in other investors.

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