I’ve been getting questions lately about the subject of wash sales. While I’m not an accountant (and you should check with one to make sure I’m right) here’s an explanation of what a wash sale is, which every investor should know so as to avoid them.
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Often it is a good idea to take losses to offset gains. Let’s say that you’ve had some big gains, but also bought a stock that just hasn’t worked out. If you still believe in the company, and think they have good long-term prospects, you may not want to sell it, for fear that you might jump out just before the big move upwards. So let’s say that you sell the stock so you can book the loss, and then immediately put in an order to buy more shares. You have just committed a wash sale, which will prevent you from deducting the loss on the stock. The point is that the IRS doesn’t want you deducting losses when you really haven’t closed the position. The same would be true if you bought more shares just before you sold the original ones.
To avoid a wash sale, you must not buy more shares of a stock within 30 days of selling the original shares for a loss, or within 30 days afterwards. So if you want to take a loss in a company but still maintain a position, either plan well ahead and buy shares more than 30 days ahead of time, or be ready to wait 30 days afterwards and hope the stock doesn’t take off in the mean time. Of the two strategies, the first option is probably optimal if you’re right about the stock since you may actually regain some of the loss before selling the shares. Waiting 30 days afterwards to rebuy may mean you’ll miss the big move up, or just never get around to buying the shares again.
Note that it is not a wash sale if you buy several shares at the same time and then sell part of the position (again, check on this), since in that case you are just selling off part of your position and reducing exposure. Note also that when you’re dealing with funds, you can’t sell one fund and buy a substantially similar fund within the 30 day window. For example, selling a Vanguard S&P 500 fund and buying an S&P500 ETF.
One of the main advantages in long-term investing is the ability to delay capital gains taxes. As a company becomes more valuable and increases in price as a result, as long as you don’t sell and realize a capital gain, your investment can keep growing without you needing to pay taxes on the increase in value. This allows the money you would have been paying in taxes to compound and grow more income for you. This is true even in a taxable account.
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