The Wash Sale Rule and Tax Loss Selling of Stocks

by Tim Parker on January 26, 2010

Taking a look at an investment rule and its tax saving implications.

It’s that time of year again. Now is the time when investors start thinking about their taxes. Maybe you’re like me: the taxes I pay on my gains aren’t a daily part of my investment thinking. (Although it probably should be.)

I’ve been checking my online broker accounts, looking at my gains and seeing some very good runs, especially since March 2009. Since the stock market bottomed out last year, the market has appreciated rapidly. Thinking that I may be paying 25% or more on those gains is less than exciting!

Remember that it’s not moral, ethical, or in the spirit of capitalism to evade paying taxes. Finding illegal ways to avoid reporting gains is not only immoral, it can also come back to hurt you later.

wash sale rule, tax loss harvesting
Image from Ag In Art

I have some stocks that I’ve had in my portfolio for quite a long time. While they should be performing better (and I believe that they will), they haven’t been reaching their potential just yet. They are tying up my money without paying me anything, so I have marked them as prime candidates for some tax loss selling.

Many investors look at tax loss selling as one of those things to do before the end of the tax year. I’ve looked at selling my losers to help offset the gains that I’ve made in other areas. This is easily done by selling weak stocks for a loss, which will then offset an equal amount of gains you make in other stock sales.

The Wash Sale Rule and Tax Loss Selling of Stocks

When thinking about tax loss selling, there’s an IRS rule that we have to keep in mind. This is referred to as the wash sale rule. What this rule states is that you can’t buy a security in the same asset class 30 days before to 30 days after the sale of the original security, if you plan to claim a tax loss.

Let’s look at an example. Maybe you own 500 shares of Microsoft stock. You bought this stock a while ago and the stock price is down, but you still believe that Microsoft is worth holding. Your plan is to sell your current shares so you can claim a tax loss, then buy 500 more shares of Microsoft the next day.

The wash sale rule is going to prevent you from doing this. In order to claim a tax loss, you’re going to have to wait 31 days after the sale of your stock before you buy it back. You also can’t buy 500 shares of Microsoft up to 30 days before selling your original shares.

You also cannot buy a similar stock. If you sell your Microsoft shares, the 60 day rule would also apply to Apple, Yahoo, or any other stock that is similar to your original Microsoft shares.

The good news about this rule is that there are a lot of stocks and a lot of sectors to choose from. If you believe in Microsoft, look into investing in another sector for 31 days, then later reevaluate Microsoft. Often, you will find that a stock that you shelved for that period of time is just as attractive after the time period expires, especially if you are a long term investor.

Tax loss selling is a legal way of offsetting capital gains taxes. Remember though, we shouldn’t buy and sell stocks based on the tax man. A good company is a good company regardless of the tax implications.

If you have made money this year, congratulations. Now take a look at your investment portfolio and see what you may be able to sell to offset some of your gains.

Tip: For more information about saving on your taxes, check out this article on 2009 tax credits.

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