The basics of the wash sale rule are probably familiar to most financial advisors and more experienced investors. However, there are some scenarios that can trip up advisors and their clients and could result in claimed tax losses being disallowed. It is important that advisors and clients work with a tax professional to help ensure this does not occur.
Wash Sale Rules: A Refresher
In investing, the term "wash sale" is broadly defined as an attempt to recognize a tax loss without actually changing an investment position. In choosing to enact a wash sale, an investor sells a security that has lost value in order to claim a capital loss on their taxes — which can result in a lower tax bill. In theory, the investor can then repurchase the security and return to an investment position similar to the one held prior to the sale.
Such a transaction may seem like an easy way for advisors and their clients to alleviate tax liabilities. However, in order to prevent wash sales from being exploited, advisors and their clients are required to adhere to the "wash sale rule." The wash sale rule prohibits a taxpayer from claiming a capital loss and tax advantage on the sale or trade of a security if a "substantially identical" security is purchased 30-days before or 30-days after this sale.1
4 Wash Sale Scenarios To Avoid
Advisors and their clients should partner with a tax professional to help ensure that assets are managed in accordance to tax rules. The scenarios outlined below describe situations where the wash sale rule could be inadvertently violated, which could lead to a client having to forfeit the tax loss on the sold securities.
Scenario #1 An advisor and their client sells shares in Stock A at a loss, planning to use the loss to offset gains. However, when talking to their spouse, they realize that he or she has just purchased Stock A for their own portfolio.
Takeaway: A tax professional is likely to remind an advisor and their client that wash sale rules apply across an entire household and to any businesses that an investor may own.
Scenario #2 An advisor sells Stock B for a loss, looking to stockpile capital losses to help offset a planned business sale by the client in the near future. The advisor later finds out from the client that he or she had purchased Stock B for another part of their portfolio that the advisor didn't control.
Takeaway: Advisors and their clients should work together — in conjunction with a tax professional — to ensure that any changes made in portfolio positions are not made to the detriment of the client’s broader tax planning strategy.
Scenario #3 An investor buys shares in Stock C for their taxable portfolio. A few weeks later, they sell Stock C shares out of their retirement portfolio after a disappointing earnings report causes the stock’s value to decrease.
Takeaway: Retirement accounts are a part of a household’s assets. Advisors and their clients should make a tax professional aware of any holdings changes that could have wash sale rule implications.
Scenario #4 An investor participates in an automatic investment plan for Stock D, buying $250 shares of Stock D each month. During the course of the year, an investor sells a large block of Stock D at a loss.
Takeaway: In this scenario, a tax professional is likely to remind the advisor and client that because of the ongoing automatic monthly purchases, the investor cannot claim a tax loss.
Playing By The Wash Sale Rule
By proactively planning how to harvest losses on an ongoing basis with clients and their tax professional, financial advisors can help them move closer to both their short and long-term financial goals while remaining compliant with wash sale rules. More information on portfolio construction and tax management is available at durableportfolios.com.
1 The entire period lasts 61 days.
Natixis Global Asset Management does not provide tax or legal advice. Before acting on information herein, individuals should consult a qualified tax advisor or attorney regarding their specific situation.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.
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