Due to the coronavirus pandemic, we’ve seen significant ups and downs of the stock market. Investors are then likely to face the challenge of balancing investments and income tax.
You may, on one hand, view the stock market crash as an opportunity of benefiting from capital losses. Keep in mind that with capital losses come reductions in income tax liability.
You may, on the other hand, still hold on to your shares of stock. Perhaps you believe that the stocks will rebound sooner than later. If you’re this type of investor, you should know about the wash rule and, better yet, discuss its details with your Liberty Tax advisor.
The Wash Sale Rule
Basically, the wash sale rule allows the taxpayer to maximize his expected tax benefit upon the realization of capital loss. Think of it as winning despite the losses or recouping part of your losses.
Generally speaking, you can offset a capital loss against a capital gain, both of which should be realized in the same taxable year. In case the capital gains is fully offset by the capital loss, a maximum of $3,000 capital losses can be used as an offset against ordinary income. This is also true if the taxpayers doesn’t have capital gains in the same taxable year.
The Restrictions of the Rule
As stated in Section 1091 of the Internal Revenue Code, the use of capital losses is restricted. For one thing, a taxpayer isn’t allowed to recognize losses on the sale of shares and securities in he enters into a contract for the acquisition or acquires identical shares and securities within 30 days of the date of sale. The 30-day period is applicable either or before said date of sale.
But the disallowed loss isn’t lost permanently. This is because it’s added to the reacquired shares or securities’ basis and, thus, it will be recognized once the reacquired assets are sold at a later time.
For example, let’s assume that you purchased 1,000 shares at $10/share resulting in a $10,000 total basis. If you sell all 1,000 shares for $4/share, your total loss is $6,000. Then you repurchased the 1,000 shares at $7/share after 25 days.
In this case, you cannot claim the $6,000 as a loss on your tax return. But the basis for the 1,000 shares will be $13,000 (not $7,000 only). If you subsequently sell the shares for $15/share after reacquiring it, your recognized gain will only be $2,000! The $6,000 disallowed loss acts as a tax benefit.
This information will be of use when you’re planning to get the most benefit from your shares of stock in these uncertain times.