What is the Wash Sale Rule?
Wash Sale Rule is a regulation laid down by the internal revenue system (IRS) of the United States to disallow a tax deduction when an investor sells the security at a loss and then buys the same or identical security from the market within a period of 30 days, thus rebuilding his position and also taking a tax benefit on the capital loss suffered.
The period of the wash sale rule is actually 61 days, which starts from 30 days before the stock or the bond has been purchased and 30 days after the stock or the bond has been sold in the market. Hence if you want to book a loss in your tax return merely by selling the security, you need to keep close attention on the dates of buy and sell of the security since it will affect the taxation system.
- This rule is not applicable in India, but it is applicable in the United States of America and the United Kingdom.
- It is framed so that the taxpayersThe TaxpayersA taxpayer is a person or a corporation who has to pay tax to the government based on their income, and in the technical sense, they are liable for, or subject to or obligated to pay tax to the government based on the country’s tax laws.read more do not take undue advantage of the fall in prices to book the capital losses and then repurchase the same to rebuild the lost position.
- What constitutes identical security is framed by the Internal Revenue System in its policies; however, generally, the bonds and preferred stock of the same company are not considered as identical, and the individual is free to buy them without attracting this disallowance of the section in the internal revenue system.
- If the loss has occurred and the same is disallowed as per the wash sale rule, then the loss needs to be added to the purchase price of the stock since the tax has already been paid on it. This new cost will be the acquisition price for the security, which will be used as a deduction when the security is further sold in the market.
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Source: Wash Sale Rule (wallstreetmojo.com)
Examples of Wash Sale Rule
Example #1
Let us say Mr.A buys 1000 Shares of Apple on January 01, 2019, amounting to Rs $50,000 ay $50 per share. On January 08, 2019, the price of the shares fell to $40, thus reflecting a notional loss of $10,000 for Mr.A. Now he sells the Stock in panic immediately and buys backs the same on January 20, 2019, thus rebuilding his earlier position and also booking a loss in his return of income to the IRS.
In this case, this transaction would be considered a wash sale because Mr.A has sold the stock and bought it back before the expiry of 30 days from the date of sale. IRS will disallow the capital loss, and the same will be added back to the cost of acquisition on January 20, 2019.
Example #2
Suppose Mr.A bought 1000 shares of Google at $100 on January 15, 2019. He sold the same on January 31, 2019, and again purchases on March 01, 2019. In this case, there is absolutely no problem with the buyback date since it is after 30 days from the sale date. However, Mr.A has originally bought the shares on January 15, 2019, and sold the same before the expiry of 30 days.
In this case, also wash sale rule will be applicable, and the loss booked as a capital loss will be disallowed in the tax return of income for that year.
Example #3
Mr.A buys a bond on January 01, 2019, sells it on March 01, 2019, and repurchases the same on May 01, 2019; in this case, there will be no applicability of the wash sale rule since the 30 days condition for the sale and repurchase of the bond has already been taken care and the capital loss if any of the security sold will not be disallowed as a deduction in the return of income for that calendar year.
Advantages
Below are some of the Advantages :
- Wash Sale Rule helps the internal revenue system (IRS) of the country to curb the malpractice, followed by individual investors to avoid taxAvoid TaxTax avoidance is the process of reducing the income tax liability of an individual or firm by adopting the lawful methods. The taxpayers can claim exemptions and deductions as allowed under the nation's tax provisions. Such as investments in municipal bonds and deductions for business loss.read more and claim deductions.
- A high amount of revenue for the authorities;
- Stock manipulations under the lens of the tax authorities
- Avoids malpractices in the stock prices;
- The capital loss disallowed is allowed as an addition to the cost of acquisition of the stock and shall be allowed as a deduction from the further sale of the repurchased security.
Disadvantages
- Long records need to be maintained by the individual investors regarding the date of purchase, date of sale, and date of repurchase to avoid the wash sale rule.
- The tiring task for the individual investors to adhere to the regulations
- No clarity on identical purchases or repurchases of the security;
- It will be a tiring task to the individual investors to be sure that the wash sale rule does not apply to them for any of the securities that re been sold in the open market since there is a penalty in the IRS for wrong disclosure of the facts and claiming wrong exemptions or deductions as the case may be in the return of income.
- Massive responsibility on the tax preparers to carefully assess the allowance or disallowance of the capital lossesCapital LossesCapital Loss is a loss when the value of the consideration received from the result of the transfer of capital assets is less than the aggregate value of the cost of acquisition & cost of the improvement. In simpler words, it can be stated as the loss derived from the transfer of capital assets.read more incurred by the individual taxpayers or investors.
Conclusion
Wash Sale Rule is one of the debatable topics in the tax structure since it has many loopholes in it regarding the dates, re-purchase of identical securities. This rule is not applicable in India; however, in the US, it is more stringent.
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