The wash sale rule applies to traders as well as investors, unless the trader elects to operate under the mark-to-market regime. If you don't make that election and you're in and out of the same stock frequently, record keeping for wash sales can be a problem.
If you have wash sales, the disallowed loss gets added to the basis of the replacement shares. That means a subsequent sale produces a smaller profit or a bigger loss. For example, if you have a wash sale with a $20 loss disallowed, then get a $5 profit when you sell the replacement stock, you'll report a $15 loss rather than a $5 profit on that sale. And if you buy replacement stock within 30 days before or after that sale, you've got another wash sale.
Obviously this is an incredible headache for an active trader. And unfortunately, it isn't true, as the previous response indicates, that you're always free and clear if you have an overall profit in a particular security. For example, you could have a $100 profit up until your last couple of trades, but then have a loss that reduces your profit to $80 in a wash sale. You don't get to claim the loss from the wash sale just because you had profits earlier in the year. It's only when the profits come after the losses that they clear out the disallowed deductions.
There are basically four solutions to dealing with this problem. One is to actually do all the record keeping necessary to track wash sales. That's a very difficult task for active traders. Second, you can liquidate all positions and take 30 days off at the end of the year. That guarantees that all your losses will be allowed, and you can resume in January with a clean slate as far as wash sales are concerned. Third is the new mark-to-market election, which carries with it the elimination of the wash sales rule (but also requires you to treat gains as ordinary income and prevents you from deferring income by holding appreciated positions at the end of the year).
If you don't like any of those approaches, you might consider making a good faith effort at determining the amount of disallowed loss you have at the end of the year with a partial analysis based on where the significant losses are. I can't recommend this approach because it doesn't really comply with the law, but if you do a reasonable analysis in good faith, in circumstances where literal compliance is so difficult that it hardly makes sense, you probably have little audit risk.
I've seen one more approach advocated here, and that is to simply take the position that the wash sale rule doesn't apply to securities traders. This approach ignores the fact that Congress specifically amended the Internal Revenue Code to make the wash sale rule apply to traders. Because the law is so clear on this point, I feel it's irresponsible to recommend that traders take this approach.
Kaye Thomas, author
Fairmark Press Tax Guide for Investors
fairmark.com |
