It’s an undeniable fact that stock values have a tendency to fluctuate in value dramatically – and unpredictably. For those who end up on the wrong end of stock investment, claiming a tax-saving capital loss deduction is often what saves them from dire financial straits.
Tax-loss harvesting is a practice that runs rampant among investors, particularly as the end of the year draws nearer. However, investors everywhere should know that under the wash sale rule, tax savings in some investment situations have been disallowed.
When is a capital loss deduction disallowed?
If an individual invests in securities that are identical enough to the ones they sold at a loss within a certain timeframe, the IRS will not allow the deduction. The IRS looks at a 61-day window that starts 30 days prior to the loss sale and ends 30 days after the fact. If the person invested in securities that were significantly similar to the ones sold, it can be expected that the IRS won’t allow the deduction.
The reasoning behind the wash rule is that the combination of these investment actions effectively creates the economic equivalent of a “wash,” meaning that the system was played and no advantage was gained by anybody through the transactions.
Investors should keep in mind that a loss isn’t vaporized in the event of a disallowed wash sale loss. Generally, the disallowed loss is simply moved over to the identical securities that caused the wash sale rule to apply. Once those substantially identical securities are sold, either your taxable gain is reduced or your tax loss is increased as a result of the extra basis. In this way, the disallowed loss is shifted into a deferred loss.
It’s prudent for anyone playing in the investment game to keep the wash rule in mind so they avoid financial problems when tax time comes. This rule disallows investors from saving money on taxes through capital loss deductions when they’ve recently purchased securities that are substantially identical to the ones sold. Being aware of this rule and following it can only serve to help the success of your investing career.