Wash Sale Rules
The following is a summary of a conversation with Amar Shah, CFA, CFP®, Founder & CIO, Client First Capital, and Kyle Lynch, CPA, Founder of Clover Hill CPA, about wash sales—what they are, and the rules that impact securities, crypto, and more.
This conversation was published on the Client First Capital Learning channel on YouTube on June 12, 2021.
Amar: What are wash sales?
Kyle: The wash sale rule is when you sell a security, and then purchase an identical security back within 30 days. What the rule does is disallow your tax loss, and I think it defeats the purpose of a lot of people selling off the security and purchasing it right back. The IRS is keen to this, and it’s been an established rule for many years.
Amar: It’s one of those things that you got to be really careful. Those that have dividend reinvestment can unintentionally create a wash sale too, right? It also doesn’t have to be in the same account, right? It could be in different accounts that this can happen.
Kyle: That’s right, every security has a CUSIP number, and that’s tied to your social security number. You can’t get cheeky and think that you can sell in one account and buy it back into another. If you have a Vanguard account, and Fidelity, or you sell in your brokerage account and buy it back in your IRA, that all gets tracked for the wash sale rules, because this has been a long-established rule. It’s IRS and SEC regulations and they’re all hip to it.
If we’re doing publicly traded securities, you have to be really careful. I’m very aware of these rules, and I had wash sales in my account last year, just because I was careless. I forgot I sold this small piece of one security last year. It’s easy to get caught up in and it’s something you should be monitoring across all accounts.
When you have a wash sale, it’s not typically lost forever. If you sell a security and buy it back within 30 days, usually you just adjust the basis on the security, so it just defers your tax loss until later. One caveat is that if you sell in a brokerage account and buy it back in an IRA, now you’ve lost it forever. You can’t recapture that because the IRA is not going to have the basis adjustment that you had in the initial sale. It can really affect the timing of your losses, so if you’re trying to do some tax planning, you have to be very careful. And then also buying across accounts.
Amar: Wash sale rules have been here for a really long time. What hasn’t been in here for a really long time is crypto. How do wash sale rules impact cryptocurrencies? Would you say that it’s an advantage, with how crypto is treated regarding the wash sale?
Kyle: I just learned about this this year. A lot of things are evolving with cryptocurrency and the IRS ruled years ago that cryptocurrency is property, so it’s not a security currently. It’s treated as property, and you’re not subject to these wash sale rules under the current tax code. What this allows you to do is if there are losses, and there’s a big dip in the crypto markets, you could sell off all of your crypto and buy right back in and have no wash sales. Let’s say you have Bitcoin at 50,000, and it dips down to 35,000. You can sell your 1.1 bitcoin, and then buy back in at 1.5 and then you get a little bit more of the upside. When it goes back up, you still get to recognize that tax loss. You don’t get that advantage on securities. That’s the law as written right now. I wouldn’t count on that being the law going forward. This is an evolving space, and I think regulations typically lag behind what’s happened in the true market. Cryptocurrency has been traded more frequently, and the speed and volume of trading has increased exponentially in the last 12 months. I wouldn’t count on this being a rule going forward, but as it stands right now, you wouldn’t be subject to the wash sale rules on cryptocurrency.
Amar: Let’s say you buy Apple stock, and then you sell it. You have to wait 30 days, plus, before you can buy it again to avoid the wash sale rule. Most people with index funds have tried to find an index that closely resembles the original index that they bought, but they can’t be more than 70% similar or something like that. There’s an IRS rule breakout that’s around that.
With crypto, the biggest difference is you could sell or capture that loss and buy right in right away, and not have that 30 day wait. With the volatility that you see within the crypto space, this is a huge advantage. You can essentially tax loss harvest as much as possible, or as frequently as possible. One thing that we should say is that you’re resetting the basis though, and eventually, when you have that big of a gain, you’re going to have a larger capital gain just later on down the road.
Kyle: That’s right. You’re also resetting your holding period. So, if you ever wanted to achieve the long-term capital gains, you’re setting yourself back on the clock to hit that 12-month horizon on long term capital gains versus short term capital gains.
Amar: What we’re trying to say is that, yes, this wash sale is a benefit for crypto investors, but you have to be careful, you have to look at your time period. If you’re a long-term investor, then this is probably more in line with that. You may be triggering short term capital gains, if you need to sell within 12 months, because you’re resetting that clock. Is there anything else that we should think about when we’re harvesting gains or doing a wash sale rules that we have a covered?
Kyle: I think the gist of it is that the IRS won’t let you take the tax loss until you have a true economic loss, right. There are a few small things you can do and keeping track of all your accounts and being aware of it will put you ahead of the curve.
Amar: Obviously, we’re just trying to provide education. Consult with your own tax advisor, your own investment advisor, to see if there’s strategies that apply to your specific situation.
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