June 15: Buy 10 shares
of XYZ at $92 per share (Lot B)
Example 3: No wash sale triggered
January 1: Buy 10 shares
of XYZ at $100 per share (Lot A)
June 1: Sell 10 shares
of XYZ (Lot A) at $90 per share for a total loss of $100
In Example 1, even though the sale was from stock purchased in Lot A, which was bought more than 30 days ago, since it occurred within 30 days of the Lot B purchase, it triggered a wash sale. And in Example 2, even though the sale happened more than 30 days after the original purchase, the additional purchase 15 days after the sale also triggered a wash sale. In cases where there’s only one lot to sell, as in Example 3, the wash-sale rule doesn’t apply.
What Happens when a Wash Sale is Triggered?
The consequences of a wash sale can be administratively annoying, but they aren’t dire. If a trade triggers a wash sale, the IRS disallows the realized loss and the loss of the sold shares is transferred to the cost basis of the recently bought shares (known as “replacement shares”). So in Example 1 above, the $100 loss realized on June 15 is disallowed for reporting on the current-year tax return and $100 of cost basis is transferred to the replacement shares—which in this case are the 10 shares from Lot B purchased on June 1. Lot B sees its original cost basis of $950 (95 x 10) increase to $1,050 ($950 + 100). Similarly, in Example 2, Lot B’s cost basis rises from $920 to $1,020.
Can you Avoid Wash Sales?
To an extent, yes. At Parametric, when we sell a security at a loss, we immediately purchase a set of similar securities that match the security we sold from a risk perspective. We also make sure we don’t buy back the same security within 30 days. Similarly, when we purchase securities we try not to sell those securities within 30 days.
That said, while we do what we can to avoid triggering wash sales, they can happen from time to time. For example, if we sell a security at a loss and a few days later the client instructs us to invest a large amount of money in the account, we may purchase shares of the recently sold security and trigger a wash sale. However, while the prior loss is disallowed, the cost basis of the replacement shares increases, which means there’s a reasonable chance we can help the client harvest a tax loss from it in the future.
The Bottom Line
The wash-sale rule is simply the IRS’s way of discouraging stock sales motivated primarily by tax reasons. Some investors resent it, some appreciate its intent, but regardless—it’s been part of the fabric of investing since 1954, when Congress passed the law, and it isn’t likely to disappear anytime soon.
It can be a tricky rule to navigate, but there are ways to work around it to help investors continue to harvest losses. Still, sometimes it’s hard to avoid triggering a wash sale and, depending on the situation, not always cost effective to do so. In consultation with the client, explaining the trade-offs is always helpful, whether they choose to avoid a wash sale or accept it with the knowledge that eventually it will all come out in the wash.
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