The term wash sale conjures up thoughts of a laundry, doesn't it? Not so when you hear it in a Wall Street conversation. It means the simultaneous buying and selling of a particular stock. In the old days this activity, together with planned publicity, was calculated to show a vast amount of activity in the stock, create interest, and drive the price up. If you buy and sell enough stock enough times it doesn't cost you much except brokerage fees, yet it can make it look as if the public is frantic to get hold of the issue and is buying it like crazy. Obviously, for this to be successful, a lot of people with a lot of money had to be planning together. Then when the stock had gone up about as high as they thought it would go, they sold it short, drove the price down, and "made a killing"--profited handsomely--when they bought the stock at the lower price. Doing this is now strictly against the law and is closely watched for by the SEC.
The modern reason for a wash sale is to establish a profit or a loss for income tax purposes. You may have all sorts of losses or gains on paper, but they don't count for tax purposes until you actually sell the stock in question. To do this you may feel it is to your advantage to buy the stock back again immediately once your profit or loss has been established.
Well, you can do this, all right, if by doing it you establish a profit. But if you establish a loss, the law will not let you take the loss on your income tax. You can't take the loss if you repurchase the stock within thirty-one days. And this, of course, makes the procedure pretty dangerous because a lot can happen in thirty-one days. A sharp rally while you are sitting out the thirty-one days can cost you more than you planned to save on taxes before you can get your stock back again. Just as an example, suppose you are in the 25% tax bracket and your one hundred shares of United Overshoe have dropped from $40 to $30. You have confidence in the company and want to continue to hold the stock but want to establish the $1,000 loss to cut down your income tax.
The day after you sell the stock to do this, it starts up. And by the end of the thirty-one-day waiting period it has regained five of the ten points it had lost. Now you're in a real mess. The $250 (25% of $1,000) tax saving you had counted on is more than wiped out by the additional $500 you have to pay to get back your stock.
You had hoped to hold your loss to a paper loss and you could have done so by buying back the stock at the price at which you sold it. Instead, you have to wrestle up $500 extra or else buy back less stock than you had held originally. Sure, you can subtract from this $500 the tax saving, but that comes next year when you file your income tax, and this is real money on the line now. To all this is added the brokerage fees on the two transactions. The whole thing becomes a disaster.
Okay, you say, I'll borrow the money, buy one hundred shares of United Overshoe first, and then sell my original one hundred shares afterward and pay off the loan. That way I'll have the one hundred shares at the low price for sure.
Right. But the wash sale rule says you've got to wait thirty-one days after the purchase to sell your original stock if you are to be allowed to take the loss on your income tax. If the price of the stock goes up in the meantime you won't have so much loss to declare, and this is good. But if it goes down you get less for the original stock when you sell it, maybe enough less to wipe out your tax saving. Because you will get an amount of money short of what's needed to pay off your loan. And again there's the brokerage fee. Any way you manage it, that thirty-one-day wait is a menace, just as the tax people intended it to be. It makes wash sales, to establish a tax loss, a gamble.
The modern reason for a wash sale is to establish a profit or a loss for income tax purposes. You may have all sorts of losses or gains on paper, but they don't count for tax purposes until you actually sell the stock in question. To do this you may feel it is to your advantage to buy the stock back again immediately once your profit or loss has been established.
Well, you can do this, all right, if by doing it you establish a profit. But if you establish a loss, the law will not let you take the loss on your income tax. You can't take the loss if you repurchase the stock within thirty-one days. And this, of course, makes the procedure pretty dangerous because a lot can happen in thirty-one days. A sharp rally while you are sitting out the thirty-one days can cost you more than you planned to save on taxes before you can get your stock back again. Just as an example, suppose you are in the 25% tax bracket and your one hundred shares of United Overshoe have dropped from $40 to $30. You have confidence in the company and want to continue to hold the stock but want to establish the $1,000 loss to cut down your income tax.
The day after you sell the stock to do this, it starts up. And by the end of the thirty-one-day waiting period it has regained five of the ten points it had lost. Now you're in a real mess. The $250 (25% of $1,000) tax saving you had counted on is more than wiped out by the additional $500 you have to pay to get back your stock.
You had hoped to hold your loss to a paper loss and you could have done so by buying back the stock at the price at which you sold it. Instead, you have to wrestle up $500 extra or else buy back less stock than you had held originally. Sure, you can subtract from this $500 the tax saving, but that comes next year when you file your income tax, and this is real money on the line now. To all this is added the brokerage fees on the two transactions. The whole thing becomes a disaster.
Okay, you say, I'll borrow the money, buy one hundred shares of United Overshoe first, and then sell my original one hundred shares afterward and pay off the loan. That way I'll have the one hundred shares at the low price for sure.
Right. But the wash sale rule says you've got to wait thirty-one days after the purchase to sell your original stock if you are to be allowed to take the loss on your income tax. If the price of the stock goes up in the meantime you won't have so much loss to declare, and this is good. But if it goes down you get less for the original stock when you sell it, maybe enough less to wipe out your tax saving. Because you will get an amount of money short of what's needed to pay off your loan. And again there's the brokerage fee. Any way you manage it, that thirty-one-day wait is a menace, just as the tax people intended it to be. It makes wash sales, to establish a tax loss, a gamble.
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