Usually if you sell securities and the transaction results in a loss, you can use the loss to offset capital gains, plus up to $3,000 of ordinary annual income. Any excess loss over that amount is then carried over and can be used to offset losses next year. Because of these tax benefits, investors often "harvest" losses from securities sales, especially at the end of the year.
But there's a potential stumbling block. Under the "wash sale rule," you can't claim a loss from a securities sale if you acquire substantially identical securities 30 days before or after the date of the sale. The loss is disallowed for tax return purposes.
What is considered substantially identical? Clearly, if you buy back the same stock it will trigger the wash sale rule, but not necessarily if it's the stock of a company that's merely in the same industry. However, transactions involving mutual funds within the same family of funds could cause a loss to be disallowed.
Frequently, a wash sale occurs when you reacquire securities you just sold at a loss because you believe the price is about to rebound. There are two relatively easy ways to avoid a wash sale.
1. Wait until 30 days have passed before you buy the same or similar securities. This preserves the loss without any question.
2. Use a "doubling up" strategy. Buy the same amount of the security you want to sell for a tax loss, temporarily doubling your holdings. Wait at least 31 days, and then sell the original batch of shares for a loss. Now you have your deductible loss, still own the same amount of shares, and can benefit from future appreciation.
If your loss is disallowed because of the wash sale rule, you can still find some tax solace. The amount of the disallowed loss is added to your basis in the shares you reacquired. Thus, when you eventually sell those shares, either your tax loss will be increased or your taxable gain will be reduced.
