Many traders do not understand wash sale rules; failing to do so can lead to huge tax problems. Below is the definition of wash sales and how to account for them according to the IRS.
A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale you:
- Buy substantially identical stock or securities,
- Acquire substantially identical stock or securities in a fully taxable trade,
- Acquire a contract or option to buy substantially identical stock or securities, or
- Acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA.
If you sell stock and your spouse or a corporation you control buys substantially identical stock, you also have a wash sale.
If your loss was disallowed because of the wash sale rules, add the disallowed loss to the cost of the new stock or securities (except in (4) above). The result is your basis in the new stock or securities. This adjustment postpones the loss deduction until the disposition of the new stock or securities. Your holding period for the new stock or securities begins on the same day as the holding period of the stock or securities sold.
In the video I describe how I use a program, Tradelog, to account for wash sales. Another option is to become a mark-to-market (MTM) trader. To be a MTM trader you must fit the criteria to have trader tax status (as opposed to investor tax status).