Tax-loss harvesting is a strategy that you can use to minimize your tax liability. By selling investments with unrealized losses, you can realize a capital loss that you can use to offset capital gains made on other investments or up to $3,000 in ordinary income each year.
The controversial part of tax-loss harvesting comes if and when you repurchase the investment. If you immediately repurchase the same investment, you’ve essentially represented that you lost money when you haven’t really lost anything – you still own the same asset!
The IRS discourages these superficial transactions with the Wash Sale Rule. While the agency hasn’t clarified whether the rule applies to cryptocurrencies, many regulators and legislators have expressed interest in closing what they see as a loophole.
In this article, we’ll get you up to speed on what a wash sale is, the rules applying to them, and how you can time your trades to avoid running afoul of these complicated rules.
What is a wash sale?
IRS Publication 550 defines a “wash sale” as a sale that occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale you:
- Buy substantially identical stock or securities.
- Acquire substantially identical stock or securities in a fully taxable trade.
- Acquire a contract or option to buy substantially identical stock or securities.
- Acquire substantially identical stock or securities for your individual retirement accounts.
This definition begs the question: What is a “substantially identical” stock or security?
The IRS says you must “consider all the facts and circumstances in your particular base” when making that determination. As an example of this ambiguity, ordinary stocks or securities of one corporation are generally not substantially identical to those of another. But, in a reorganization, the predecessor’s stock may be “substantially identical.”
The Wash Sale Rule prohibits investors from deducting the sales or trades of “stock or securities” in a wash sale (unless you’re a dealer in stock or securities).
If you think about it, selling stock to realize a loss and immediately repurchasing the asset results in a net-unchanged economic position for you. You owned the same asset with the same economic exposure as before – you’re only changing your cost…