Example 1: You sell, at a loss, shares of a mutual fund that is invested in the S&P 500 index. On the same day you purchase a mutual fund that is invested in a total stock market index. The two investments are not substantially identical, so you avoid wash sale treatment. If you instead purchased another mutual fund (perhaps with another fund family) that invests in the S&P 500 index, you will be subject to the wash sale rules because the new fund is substantially identical to the original fund.
Example 2: You sell, at a loss, shares of a mutual fund that owns a portfolio of Treasury Inflation-Protected Securities (TIPS). Within 30 days you use the proceeds from the sale to purchase another mutual fund that invests in GNMA bonds (Government National Mortgage Association, or Ginny Mae). This set of transactions avoids the wash sale, because GNMA bonds are not identical to TIPS.
Example 3: You sell your S&P 500 index investment mentioned in example 1. You wait 30 days, and on the 31st day you purchase the exact same (or another fund family’s) S&P 500 index investment. This set of transactions avoids wash sale treatment because enough time has passed (30 days) since the sale for a loss.
Examples for Handling Wash Sale Disallowed Losses
So, instead of allowing the loss, the IRS gives you the ability to increase the basis of the security that you purchased, by the amount of loss that you were disallowed.
Example 1: You own 100 shares of stock that you purchased last year for $1,000. You sell those shares for $750, and within 30 days, you purchase another 100 shares for $800. You have a disallowed loss of $250, which will be added to the basis of your current holding, making the basis now $1,050 ($800 plus $250).
Example 2: You purchase 100 shares of stock for $1,000, and then sell them for $750 within 30 days. Your loss is disallowed. In this case, since you don’t own the stock any more, the loss is just gone, unless you repurchase the position within 30 days.
Example 3: You own 100 shares of stock that you purchased last year for $1,000. You sell all 100 of those shares for $500, and within 30 days you purchase 50 shares again for $200. These 50 shares will have a basis of $450 due to the disallowed loss of $250. You would still have an allowed loss of $250 for the activity unless you repurchased additional shares within 30 days.
It can get really complicated if you have multiple purchases and sales and overlapping 30 day periods, so if you have a particular situation that you’d like to review, please let me know. Other complicating factors include the use of short sales, options, and futures contracts.
This article has been republished with permission from Financial Ducks in a Row.