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Wash Sales... their clean. Right?

A client called late Wednesday with a question on losses resulting from stock sales. An investment made many years ago had paid off recently and the client had chosen to invest the proceeds in the stock market. Using client personnel to select the stock to purchase. Seems not all of the selections increased in value. And some selections were sold at a loss and then repurchased.

The client's basic question was could the gains be offset by the losses. My answer was in two parts. First, yes losses do offset gains. Second. Except when they are "Wash Sales". And here is where it gets technical and clients get fuzzy.

Under wash sale rules a taxpayer that sales securities and realizes a loss may not take a deduction for that loss. The "wash sale rules apply if, within a period beginning 30 days before the date of sale or disposition and ending 30 days after that date (61 day period), the taxpayer has acquired, or has entered into a contract or option to acquire substantially identical stock or securities (P 1937)(Code Sec. 1091(a):Reg.SS1.1091-1)." This rule applies to short sales of stocks or securities, and to futures contract to sell stocks or securities. This rule applies even if the stock or securities are held in an IRA. And under the "related persons rule" sells of stock by one spouse count for the other spouse in determining loss deduction under this rule.

If I were to by 1000 FaceBook shares at the market price of $42 May 18, 2012 and sold 500 shares at $28 on May 30, 2012 my deductible loss on the 500 shares would be $42-$28*500 or $7,000. On June 21 I purchase and additional 1000 shares of FaceBook stock at $32 per share. The wash sale rules apply to the May 30, 2012 stock sale and I no longer have a $7,000 deduction. I purchased subtantially identical stock (FaceBook has only one class of stock) within 30 days of the date I sold the stock. Sell date was May 30th, re-purchase date was June 21st or 22 days from the sell date. The wash sale rules apply.

When wash sale rules disallow a loss the deduction is not lost. The dissallowed loss is added to the cost of the new stock or securities increasing the buyer's basis in the new stock or securities. Thiis adjustment postpones the loss deduction until the disposition of the new investment.

My basis in the FaceBook stock is:

Purchased May 30th-500 shares at $42/share; $21,000

Purchased June 21st-1000 shares at $32/share; $32,000 plus the disallowed loss of $7,000 for a total basis of $39,000 or $39/share

This "rolling forward" of the loss continues each time a transaction meets the "Wash Rule" standard. The wash sale rule was created to prevent taxpayers from selling stock at a loss in December to be reported as a deduction and repurchasing the stock in January. It seems some taxpayers were creating a loss deductions and not really loosing anything when they repurchased the stock.

To receive the $7,000 deduction now attached to the FaceBook Stock purchased June 21st I can not purchase, contract to purchase, hold an option or futures contract on FaceBook shares until 30 days after June 21st. After July 21st I am no longer subject to the wash sale rule for the stock purchased June 21st.

This is not everything there is on wash sales, this is intended only to may the reader aware of a pitfall in frequent securities purchase and sales in the same security. As always call a CPA or investment advisor who can provide information appropriate to your situation.