When it comes to the world of investments, there is a lot of excitement for potential growth. All things are good when the market does well. However, there are ALWAYS ups AND downs. In down markets, many people freak out and sell and take their losses. There are some who “know more” and take advantage of losses for tax purposes. NOTE: I AM NOT A FINANCIAL ADVISOR. THIS IS JUST FOR ENTERTAINMENT PURPOSES ONLY.
Everyone knows that with any profits, in any type of business, there is going to be tax that will eat into some of the profits. In addition to profits, there are losses that also eat into profits. However, you can be strategic in taking losses when in a down market or a bad stock. This type of strategy can lead to people realizing their losses to offset gains and immediately buying back into the same investment which can lead to abuse of this “loophole”.
Enter the Wash Rule. This is something that is in place to deter those from investing from taking a loss in the stock market for tax benefits. Now some may think “Why would there be benefits in taking a loss?” The simple answer is that in investing, there is capital gains and capital gains tax which is a tax on your gains in your investment. When you take a profit, you pay taxes. If you take a loss in addition to your profit, it offsets the profit, and you pay less taxes. Now the Wash Rule prohibits you from selling to take a loss and then immediately buying the same/similar investment within 30 days (both before or after).
For example, if I were to buy 10 Exxon Mobil stock prior to the 2020 recession, at say $75, and towards the end of the recession I sold at say $45, I would technically be down $30/share or $300. If I also had made profit on 10 NIO where I bought at $15 (I wish), and sold within the same year of 2020 for $50, I would be in the green $35/share or $350 in total. If these were all my transactions for the year, I would needed to pay capital gains tax on $50 ($350 – $300 = $50). Had I not sold the 10 shares of Exxon Mobil for a loss of $300, then I would be paying capital gains tax on the whole $350. Now if I were to buy back into Exxon Mobil right after I sold, then this would trigger the Wash Rule, effectively leaving me to pay capital gains tax on the original $350. The cost basis, which is the cost in which you bought the stock, would then be lowered.
Does This Rule Affect Tax Advantaged Accounts?
In a ROTH IRA, the wash rule does not apply. This is because the account is tax preferred, where you pay taxes upfront and all gains are tax free. The intent of the wash rule is to deter individuals from realizing losses for tax purposes and immediately repurchasing shares of the same company. Hopefully this has helped. But until next time…
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Checking out, Kenny