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Investing 101: Beware of the "Wash Rule"              

You are probably reading this because you are an investor, saw the title of this publication, and said to yourself what in the hell is a “wash rule”?  Well, I’m here to clue you in as, during the summer of 2019, I was flagged by my investment broker for violating it.

The wash-sale rule is a mandate from the Internal Revenue Service (IRS) that attempts to prevent people from finessing the system with stock write-offs that they’ve actually made a profit off of.  It’s sort of a play on the accounting term “wash”, which occurs when a series of transactions (debits and credits) ends in a zero net sum balance.

The investment term “wash rule” occurs when an individual, their spouse, or their corporation sells or trades a publicly traded investment (stock, ETF, etc.) at a loss and within 30 days before or after this sale buys a “substantially identical” stock or security.  The IRS is trying to prevent people from writing off a particular security (investment) as a loss when, in fact, they actually made a profit.

Example 1: One January 1, you buy 30 shares of X stock at $100 per share, which gives you a $3000 stake in X company.  On March 1, the stock drops to $70 per share, devaluing the investment to $2100.  At this point you decide to sell all of your shares and take the loss of $900 ($3000 - $2100 = $900).  Then, on March 15, 14 days later, X stock falls even further to $50 per share, which prompts you buy back your 30 shares at a cheaper price of $1500.  At this point the wash rule would kick in because the IRS will flag this as an investment that you cannot write because you brought the stock, or a similar stock, back and stand to profit off of it.  The IRS would prevent you from writing off the initial loss of $900 dollars.

Example 2: One January 1, you buy 100 shares of Z stock, a cell phone manufacturing company, at $3 per share, which gives you a $300 stake in Z company.  On February 1, you buy 100 shares of Q company, a cell phone manufacturing company, at $1 per share.  Then, on February 15, you decide to sell all of your shares of Z stock at $2 per share and take the loss of $100 ($300 - $200 = $100).  At this point the wash rule may be triggered because you sold one cell phone company stock at a loss but purchased a similar company that eventually turn a profit for you.

So that’s the wash rule in a nutshell.  I don’t think there’s any Bernie Madoff prison time for violating the wash rule - I’m not a professional broker or financial advisor so please check with a professional - but it appears to be just a flag that lets the IRS know to be on the lookout for you when you file your taxes and be sure you didn’t include these assets as losses on any tax forms.  But, to be on the safe side, learn from my mistakes and try not to violate the wash rule.  It will make your end-of-year tax filings cleaner, which just may help you sleep better at night.







 
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