Wash Sale Practical Details

[Chosh]

Most summaries of how wash sales work seem to be a bit more abstract than what I've looked for, so trying to put my understanding out there and get the conversation rolling for those looking for the practical details.  Looking for feedback on how correct I am on the following points:

• A wash sale occurs when you sell a security, then buy a substantially identical one within 30 days OR buy a security, then sell a substantially identical one within 30 days.
• Substantially identical is not particularly clearly defined, but most people hold that if securities track two different indices, they are not substantially identical, even if those indices are very similar (e.g. CRSP US Mid Cap Value and Russell Midcap Value)
• You are under no legal obligation to specially track and report wash sales, the IRS will let you know if you trigger a wash sale (at tax time?)
• The only penalty for triggering a wash sale is disallowing the tax loss, then resetting your cost basis and purchase date for the security to the original one before your sell and re-buy (how does this work for a buy, then sell within 30 days rather than sell than buy?).  A good approximation is that triggering the wash sale makes it as if you never did that sell and re-buy.
• Quantity matters.  If you sell 30 shares of stock A at a loss, then buy 2 shares of stock A within 30 days, the loss is only disallowed on two shares, you can still claim a loss on the other 28.
• If you do trigger a wash sale and need to adjust your cost basis, most online brokerages can accommodate this

Any important things I missed/corrections?  There are more in depth white papers out there, but wanted to get the key bullet points out there for my understanding and others'.  One good white paper with a little more detail: http://g2ft.com/papers/G2FT%20Basic%20Wash%20Sales%20White%20Paper.pdf

[seattlecyclone]

Most summaries of how wash sales work seem to be a bit more abstract than what I've looked for, so trying to put my understanding out there and get the conversation rolling for those looking for the practical details.  Looking for feedback on how correct I am on the following points:

• A wash sale occurs when you sell a security, then buy a substantially identical one within 30 days OR buy a security, then sell a substantially identical one within 30 days.

A wash sale is when you sell shares for a loss and also purchase substantially identical shares 30 days before or after. Buying shares and selling those same shares less than a month later does not trigger a wash sale in and of itself. How long you owned the shares you sold for a loss is immaterial; what matters is that you bought separate "replacement shares" within that 61 day window.

• Substantially identical is not particularly clearly defined, but most people hold that if securities track two different indices, they are not substantially identical, even if those indices are very similar (e.g. CRSP US Mid Cap Value and Russell Midcap Value)

Seems right to me. The big robo advisors seem convinced that trading between two ETFs that track nearly identical indices does not trigger wash sales, and I haven't heard of any customers having the IRS try to claim their trades as wash sales come tax time. That doesn't mean it couldn't happen, of course, just that it hasn't yet.

• You are under no legal obligation to specially track and report wash sales, the IRS will let you know if you trigger a wash sale (at tax time?)

This part is false. If you have a wash sale you need to report it as such on your tax return. Brokerages are supposed to track this for you for any "covered securities" (generally anything bought after 2011), but if you sell in one account and buy in another the brokerage has no way of knowing if it's a wash sale or not. Anyway, even if they report it on your annual 1099, you still need to report it on your tax return.

• The only penalty for triggering a wash sale is disallowing the tax loss, then resetting your cost basis and purchase date for the security to the original one before your sell and re-buy (how does this work for a buy, then sell within 30 days rather than sell than buy?).  A good approximation is that triggering the wash sale makes it as if you never did that sell and re-buy.

Yes, this is correct. The wash sale adjusts the cost basis on the replacement shares. Remember that holding shares less than 30 days is not what triggers a wash sale, so that's where your confusion comes from there.

• Quantity matters.  If you sell 30 shares of stock A at a loss, then buy 2 shares of stock A within 30 days, the loss is only disallowed on two shares, you can still claim a loss on the other 28.

True.

• If you do trigger a wash sale and need to adjust your cost basis, most online brokerages can accommodate this

I believe so.

[johnny847]

• The only penalty for triggering a wash sale is disallowing the tax loss, then resetting your cost basis and purchase date for the security to the original one before your sell and re-buy (how does this work for a buy, then sell within 30 days rather than sell than buy?).  A good approximation is that triggering the wash sale makes it as if you never did that sell and re-buy.

Yes, this is correct. The wash sale adjusts the cost basis on the replacement shares. Remember that holding shares less than 30 days is not what triggers a wash sale, so that's where your confusion comes from there.

Additionally, if those replacement shares are in a retirement account, your losses are permanentaly disallowed, because the washed loss isn't added to any "basis' in the IRA

(As a side note, tIRAs can have a basis, but wash sales where the replacement shares were bought in an tIRA don't raise the basis of tIRAs. I feel like they should, but that's a discussion fora different time).

[Chosh]

• You are under no legal obligation to specially track and report wash sales, the IRS will let you know if you trigger a wash sale (at tax time?)

This part is false. If you have a wash sale you need to report it as such on your tax return. Brokerages are supposed to track this for you for any "covered securities" (generally anything bought after 2011), but if you sell in one account and buy in another the brokerage has no way of knowing if it's a wash sale or not. Anyway, even if they report it on your annual 1099, you still need to report it on your tax return.

A bit confused by this.  If the IRS doesn't rigorously define substantially identical and therefore what constitutes a wash sale, why is the burden of identifying when it occurs on the individual brokerages/taxpayers?

[johnny847]

• You are under no legal obligation to specially track and report wash sales, the IRS will let you know if you trigger a wash sale (at tax time?)

This part is false. If you have a wash sale you need to report it as such on your tax return. Brokerages are supposed to track this for you for any "covered securities" (generally anything bought after 2011), but if you sell in one account and buy in another the brokerage has no way of knowing if it's a wash sale or not. Anyway, even if they report it on your annual 1099, you still need to report it on your tax return.

A bit confused by this.  If the IRS doesn't rigorously define substantially identical and therefore what constitutes a wash sale, why is the burden of identifying when it occurs on the individual brokerages/taxpayers?

For the record, it's not the IRS's fault. It's Congress's fault for not defining what substantially identical means.

ETA: And as for why, because Congress said so. Highly unsatisfying, but that's just the way it is.

[With This Herring]

Also, FYI, the IRS will NOT tell you that you have entered a wash sale.  They may figure it out if your return is audited, but the IRS doesn't go sending out notices for this.  The IRS doesn't track all the security purchases and sales for everyone.

[seattlecyclone]

• You are under no legal obligation to specially track and report wash sales, the IRS will let you know if you trigger a wash sale (at tax time?)

This part is false. If you have a wash sale you need to report it as such on your tax return. Brokerages are supposed to track this for you for any "covered securities" (generally anything bought after 2011), but if you sell in one account and buy in another the brokerage has no way of knowing if it's a wash sale or not. Anyway, even if they report it on your annual 1099, you still need to report it on your tax return.

A bit confused by this.  If the IRS doesn't rigorously define substantially identical and therefore what constitutes a wash sale, why is the burden of identifying when it occurs on the individual brokerages/taxpayers?

Johnny's right: because Congress said so.

You're responsible for accurately reporting all of your capital gain and loss income. This includes but is not limited any adjustments resulting from wash sales. The fact that brokerages now need to track cost basis to the best of their ability makes this a lot easier for taxpayers, but in the end you're still responsible for doing it correctly.