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Have You Been Wondering How To Do Legal Wash Sales?

Traders are often encountered with wash sales and are always on the lookout to work around it. There are certain points that can be kept in mind when a trader is in such a position. In fact, there are a few options that one can undertake.

The wash-sale rule intends to prevent taxpayers from claiming artificial losses. When conceiving tax losses, it is highly critical that one is scrupulous enough that by any means he/she does not trigger a wash sale.

Every time a wash sale happens in a non-qualified account, the transaction is marked and the cost basis witnesses an addition of loss of the substantially similar investment you purchased.

However, if one continues to trade the same or substantially similar investment, then with each transaction, the loss also gets forwarded until the position is finally wholly liquidated for a period of greater than 30 days.

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Selling Stocks at a Loss – Tax Loss Selling

Tax-loss selling is a strategy employed to offset the capital gains made on equity against the capital loss suffered so that the overall tax payable amount is significantly reduced.

Taxpayers often keep their capital gains low to avoid paying high taxes. After selling-off their stocks at a loss, investors often buy the same or similar stocks/fund units to account for the loss. If this is done under 30 days, it is a wash-sale.

One such strategy to avoid a wash-sale is to not purchase a substantially identical position inside of one’s Traditional or Roth IRA. One needs to understand what the IRS considers substantially identical.

One must note this because losses within an IRA would be confined to the IRA and fail to be deducted against capital gains, except in certain scenarios.

Legalizing Wash Sales

There have been developed strategies or walkarounds that might help a person keep all or at least a fraction of their deduction while also funding in identical securities.

1. Partial Deduction

As the name suggests, this type of transaction would let you keep a fraction of your investment by selling off more of your stocks than what is purchased later within the 61 days surrounding the sale.

How To Do Legal Wash Sales

For instance, you own 1,000 shares of ABC and sell them all at a loss, only to purchase 200 of them later, you might still be entitled to take-the-edge-off of the loss of 800 shares sold. Here, the disallowed loss and 200 shares sold shall simply be added to the cost basis of the newly bought 200 shares (Source: Investopedia). The remaining loss doesn’t disappear but simply gets delayed.

2. Additional Purchasing

If you happen to own an individual stock that holds a loss but also don’t wish to be out of the market, you can avoid a wash sale by purchasing another security and waiting or 31 days to sell-off the shares and then incur a loss.

This strategy, however, comes with a pitfall as it exposes you to elevated sector exposure and risk.

3. Liquidate the Holding

You can also liquidate the security holding, identify the loss and instantly purchase a similar investment that befits your investment target or portfolio allocation.

A simple instance includes selling Coca-Cola and purchasing PepsiCo or even selling the Vanguard Index 500 fund and invest in the Vanguard Total Market Index.

4. Multiple Accounts

When an investor possesses numerous accounts, including IRAs and Roth IRAs, wash sale rules apply to the investor and not to individual accounts. IRS regulations urge brokers to track and report wash sales of the same CUSIP number in the same non-qualified account.

However, investors are liable for tracking and reporting any sales that happen in other accounts (their own and their spouse’s) that they own, which may trigger the wash sale rule on IRS Schedule D.

5. Similar But Not Substantially Identical Securities

Another way to legalize a wash sale is by investing in stocks that are similar but not substantially identical in the eyes of the IRS.

This strategy can be extremely helpful when you intend to purchase a similarly-performing investment but don’t wish to fall victim to the wash-sale rule.

6. Entitled to Section 475

Traders who are eligible for Trader Tax Status (TTS) are automatically entitled to elect the Section 475 mark-to-market (MTM) accounting (Source: Forbes). This would exempt them from wash-sale loss adjustments as-well-as limitations of capital loss.

7. Entity Account Trading

One should try trading in an entity account to avoid wash sale losses. This is due to the fact that the company’s account is segregated from the individual or IRA accounts mainly for the purposes to prevent Wash Sales.

If the company considers itself eligible for TTS, it can avail the Section 475 MTM that exempts it from wash sales as mentioned earlier.

One can make out a detailed meaning of what exactly is a wash sale, and how does one understand how it truly works.

The bottom line

The wash-sale rule is the IRS’s way of discouraging stock sales flamed primarily by tax reasons. Some investors demean it, some acknowledge its intent. Some traders try to avoid it at all possible costs while others try to find their way around a wash sale to take-the-edge-off of their taxes and minimize capital gains.

There are strategies to work around it to help investors harvest losses from their securities sold at a loss. However, it’s hard to avoid triggering a wash sale and, depending on the situation, it might always be one’s best bet to avoid a wash sale and reduce gains. This blog has been designed to help you navigate such a situation.

In consultation with the client, explaining the trade-offs is always helpful, whether they employ ideologies to prevent a wash sale or accept it with the intellect that gradually it shall appear out in the wash.

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