Wednesday, November 21, 2007

Avoiding Wash Sales While Taking Losses For Stock Investments

If one plans to take a loss on a stock or mutual fund this year and own it again before next year, selling or buying in November enables one to avoid the wash sale rule. The wash sale rule requires that substantially identical securities cannot be bought within 30 days before of after the sale of securities for a loss. Otherwise, the loss cannot be claimed.

Here’s a scenario where one may want to sell some losses, even though the stock is still a good one for the portfolio. (For the purposes of this discussion, the term stock will refer to either stocks or mutual funds.) Because of some successful investing, one has made $5,000 on a stock that has been sold. This is good. However, another stock is down $5,000 and expected to go higher next year. If nothing is done, taxes will be owed in 2007 on the $5,000 gain.

If the shares with a loss are sold, the gain for the year will be zero, $5,000 gain minus $5,000 loss. The IRS will allow this. It would be great if one could buy back the stock the next day, thus taking the loss and still keeping the stock. However, the IRS does not allow buying back the stock within 30 days of the sale. Thus, there is risk the stock price may be significantly different when repurchased.

Personally, I like to avoid paying taxes. So I try to sell as many losses as possible near year end. Often, it is an easy decision. Sometimes, there are stocks that I want to sell outright. For those stocks that I want to continue to own next year, I manage them to avoid the wash sale rule.

I use a buy first and sell second strategy to avoid wash sales. Here are details on how strategy works:

Buy identified stocks in November. October and November are typically months when people do tax loss selling. Thus, the stock price is likely to be depressed in these months. I had had two stocks with a loss that I wanted to keep next year, Genta (GNTA) and Chico's (CHS). I bought shares of GNTA and CHS on Tuesday, November 6, 2007.

Sell identified stocks in December after 30 days. For GNTA and CHS, I can sell the older original shares for a loss anytime after December 7, 2007 and avoid the wash sale rule. My long shot hope is that GNTA will benefit some good news in 2008 for their cancer drug and CHS will benefit from improved clothing sales this winter.

If there is a sudden rise in GNTA and CHS before December 7, I will benefit from owning twice the number of shares. (I would be extremely disappointed if I had sold first and the rise happened during that time.) Of course, there are no guarantees. GNTA and CHS could go lower, creating more losses.

For more on The Practice of Personal Finance check back every Wednesday for a new segment.

This is not financial, investment or tax advice. Please consult a financial, investment or tax professional.

Copyright © 2007 Achievement Catalyst, LLC


SMG said...

I didn't realize there was such a wash rule, as a few days ago I sold a position and then immediately bought back most of the original shares. But in your example, how are the older shares to be differentiated from the new ones? Are they purchased in separate accounts?

Super Saver said...

My brokerage account keeps track of when each lot of stock is purchased. When I sell the the older shares, I will request a "versus purchase" sale, which will specify that the ealier lot be sold.

Anonymous said...

It is rather late to avoid wash sales now, but thank you for the advice.

J.C. Carvill