The saving grace of making a poor stock or mutual fund investment is that you at least get a capital loss when you sell. The loss can then offset gains from your more successful investments, unless the dreaded wash sale rules disallow your writeoff. Here’s the scoop on this nasty little piece of the tax code.
The skinny on wash sales
Your anticipated tax loss is disallowed if, within the period beginning 30 days before the date of the loss sale and ending 30 days after that date, you acquire “substantially identical” stocks or securities. For purposes of this article, let’s call them replacement securities.
According to the tax law, your loss transaction and the purchase of the replacement securities are a “wash,” so you shouldn’t be allowed any tax benefits. Please understand, however, that this righteous concept applies only to losses. If you sell for a gain and buy back identical stocks or securities within the above time frame, Uncle Sam is happy to collect his due with no qualms. (Among us tax professionals, this is known as a “heads I win; tails you lose” rule.)
Options are included in the definition of stocks and securities, so you can also have a wash sale when you unload options at a loss.
But for the wash sale rules to come into play, the stocks or securities must truly be substantially identical. Stocks or securities issued by one corporation are not considered substantially identical to stocks or securities of another.
What about replacing one S&P 500 index mutual fund with another? Unfortunately, the IRS begs the question by saying only that all circumstances must be considered in evaluating whether stocks or securities are substantially identical. What the heck does that mean? Nobody knows. In my opinion, no mutual fund is...