Let’s test your tax-filing knowledge. Myth or fact? Brokers track your wash sales.
Actually, both. It just depends.
At its most basic, the wash sale rule prevents investors from taking an artificial loss as a means to lower their tax bill. But the fine print gets more complicated.
Now, the wash sale rule is nothing new; it’s been confusing most investors since the 1920s. More recently, investors were treated to an eye-opener when these adjustments started appearing as reportable information on their 1099s a few years ago.
Enter the Emergency Economic Stabilization Act of 2008, which phased in covered cost basis reporting. With that, your brokerage firm began reporting the cost basis, or adjusted cost basis, and the holding period of your trading positions in phases spanning several years. Several actions can impact the cost of your position, and one is a wash sale adjustment. This change left many scrambling to learn what a wash sale is, how a broker tracks it, and what it really means for tax filing.
Exactly What Is a Wash Sale?
A loss is deemed “artificial” if shares are sold (at a loss, of course) within the wash sale window. This rule applies to shares of the same security, but it also includes repurchasing shares of a substantially identical security.
By rule, if you hold a position, sell it at a loss, but buy the same (or substantially identical) security within a 61-day window (that is, 30 days before or after the closing transaction), you can’t use the loss on your original sale for tax purposes. Instead, the loss is added to the cost basis of the replacement shares, deferring the loss until those shares are later sold. The holding period for the replacement shares will also be adjusted to include the holding period of the shares sold for a disallowed loss.
Wash sale adjustments aren’t exclusive to stocks; the rule applies to mutual funds, exchange-traded funds (ETFs), and option contracts, too. The rule is not limited to a single account, either. If you sell a security for a loss in your account, and your spouse or a company you control buys the same or a substantially identical security in their account within the 61-day window, the loss would still be disallowed. If you have multiple accounts across one firm or several firms, you must keep track of relevant transactions within all of these accounts, including any individual retirement accounts (IRAs). Note that most firms’ software will not track wash sales within an IRA.
It’s certainly a lot to keep track of, which is why your broker helps you out with some of it. But there are limitations. The IRS gave taxpayers and brokers different rule books when calculating wash sales. Here are a few of the basic differences:
|Broker Responsibilities||Taxpayer Responsibilities|
|Track on a CUSIP level||Track substantially identical securities|
|Track within a single account||Track across all applicable accounts held|
|Report adjusted basis only for covered securities||Report adjusted basis for ALL shares|
Does it seem like the broker is held to less stringent standards than the average taxpayer? Keep in mind that your broker is not privy to all your accounts across multiple firms, the identity of your spouse and all of their accounts, nor does it know what companies you may control. That would be a logistical nightmare! Plus, the term “substantially identical” leaves quite a bit of room for interpretation. So unless the IRS creates a database tying multiple securities together, brokers cannot realistically track all applicable transactions.
Wash sales can be complicated—the rules, the tracking, and the adjustment reporting can certainly turn into a real chore. In general, awareness of the factors that trigger a wash sale is the best way to avoid being surprised by these adjustments, come tax time. The alternative? Never sell at loss, ever. No additional tracking required! But that, of course, is easier said than done.
The information presented is for informational and educational purposes only. Content presented is not an investment recommendation or advice and should not be relied upon in making the decision to buy or sell a security or pursue a particular investment strategy.