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 prior to 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 the same is applicable in the United States of America and the United Kingdom.
- It is been framed so that the taxpayers 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 been 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 been 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 been further sold in the market.
Examples on Wash Sale Rule
Example #1
Let us say Mr.A buys 1000 Shares of Apple on Jan 01, 2019, amounting to Rs $50,000 ay $50 per share. On Jan 08, 2019, the price of the shares fall 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 Jan 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 Jan 20, 2019.
Example #2
Suppose Mr.A buys 1000 shares of Google at $100 on Jan 15, 2019. He sells the same on Jan 31, 2019, and again purchases on 01 March 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 Jan 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 Jan 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 in order to avoid tax 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 with regards to the date of purchase, date of sale, and date of repurchase in order 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 is not applicable 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.
- Huge responsibility on the tax preparers to carefully assess the allowance or disallowance of the capital losses 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 with regards to 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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