Wash Sales and Retirement Accounts: What You Need to Know

One benefit of getting rid of an underperforming asset is that you can benefit from tax-loss harvesting, which is the process of receiving a tax break when you sell it. Therefore, you wouldn’t want to break the IRS law governing “wash sales” and lose that tax break. “.

To put it briefly, a wash sale occurs when you sell a security for a loss in order to receive tax benefits, but you later purchase the same or a comparable security. It doesnt even need to be intentional. For instance, you might forfeit some of your tax benefit if you sold only a portion of a position in order to harvest tax losses and then reinvested dividends.

Understanding Wash Sales

A wash sale occurs when you sell a security at a loss and then repurchase the same or a substantially similar security within a short period, typically 30 days before or after the sale. This repurchase prevents you from claiming the loss on your taxes, as the IRS views it as a way to artificially generate tax benefits without actually relinquishing your investment position.

Wash Sales and Retirement Accounts: A Special Case

The wash sale rule generally applies to taxable accounts, but there’s an important exception for retirement accounts like IRAs and 401(k)s. Wash sales within retirement accounts do not trigger the rule, meaning you can sell a security at a loss and immediately repurchase the same or a similar security without affecting your tax liability.

This exception exists because retirement accounts already offer significant tax advantages. Contributions are often made with pre-tax dollars, and earnings grow tax-deferred until withdrawn. Therefore, the IRS doesn’t see a need to further incentivize tax-loss harvesting within these accounts.

IRA Trades and Wash Sales in Taxable Accounts

While wash sales within retirement accounts don’t trigger the rule, they can have unintended consequences for your taxable accounts. Specifically, if you sell a security at a loss in your IRA and then repurchase the same or a similar security in your taxable account within the 30-day window, the wash sale rule will apply to the taxable account transaction. This means you won’t be able to claim the loss on your taxes.

Avoiding Wash Sales in Taxable Accounts

To avoid wash sales in your taxable accounts, it’s crucial to be mindful of your trading activity in both taxable and retirement accounts. Here are some tips:

  • Wait 30 days: After selling a security at a loss in your IRA, wait at least 30 days before repurchasing the same or a similar security in your taxable account.
  • Consider selling different securities: If you need to sell a security at a loss in your IRA, consider selling a different security in your taxable account to avoid a wash sale.
  • Use a different account: If you want to repurchase a security soon after selling it at a loss in your IRA, consider doing so in a different taxable account that doesn’t hold the same or a similar security.

Understanding the wash sale rule and its implications for retirement accounts is crucial for maximizing your tax benefits and avoiding unintended consequences. By being mindful of your trading activity in both taxable and retirement accounts, you can ensure you’re claiming all eligible losses and optimizing your tax strategy. If you have any questions or need further guidance, consult with a qualified tax professional.

Q: Which securities are covered by the wash sale rule?

A security is generally subject to the wash sale rule if it has a CUSIP number, which is a unique nine-character identifier, like stocks, mutual funds, and exchange-traded funds (ETFs). Furthermore, the wash sale rule will also be activated if a security is sold at a loss and an option is subsequently purchased on the same security.

Q: How does the wash sale rule work?

You will not be able to deduct a loss for a security on your current-year tax return if you sell it at a loss and purchase the same or a nearly identical security within 30 calendar days of the sale. There are some benefits, though. As you can see below, you can add the loss amount back to the replacement security’s cost basis, which may help with taxes in the future. Furthermore, the replacement security’s holding period is extended by the original security’s holding period.

Heres an example:

Assume you paid $10 per share ($1,000 worth of stock) for 100 shares of XYZ stock. After a year, the stock begins to decline, so you sell your 100 shares for $8 apiece, resulting in a $200 loss. When XYZ is trading for $6 a share three weeks later, you decide it’s too good to pass up and repurchase the 100 shares for $600. This triggers a wash sale.

Consequently, the $200 loss is added to the cost basis of the repurchased stock and is not deducted from your current year’s taxes. As a result, your replacement stock’s $600 cost basis is increased to $800, meaning that if you later sell it for $1,000, your taxable gains will be $200 rather than $400. Furthermore, even if you sell XYZ after only a few months, it will always be recognized as a long-term capital gain because you held it for a year prior.

So, its not all bad news. A larger cost basis lowers your future tax obligation by reducing the amount of any gains you may realize from the sale of the replacement security in the future. The higher cost basis would actually increase the amount of the loss for which you could deduct expenses if you sold the investment at a loss.

Additionally, if you sold the replacement security less than a year after the extended holding period, you might be able to reduce your tax liability. (Generally speaking, longer-term capital gains are taxed at the lower capital gains rate, while short-term capital gains from investments held for less than a year are taxed at the higher regular income tax rate.)

Understanding a Wash Sale | Fidelity Investments


Do wash rules apply to IRA accounts?

The wash sale rule does not apply to retirement accounts such as IRAs and 401(k)s. This is because retirement account holders are already getting a tax break on their investments. For example, 401(k) contributions are made with pre-tax dollars, so there’s no need to deduct losses from these accounts on your taxes.

Does wash sale rule apply to all accounts?

The wash sale rule applies to all of your investing accounts, including your non-taxable retirement accounts, no matter where they are held.

Are wash sales tracked across accounts?

Brokers track and report wash sales within the same account and include the sales in the gain and loss report to the IRS. However, if the trades are in different accounts, you are responsible for tracking wash sales.

What triggers a wash sale rule?

A wash sale occurs when you sell or trade a stock or securities at a loss, and within 30 days of the sale (either before or after), you purchase the same—or a “substantially identical”—investment.

Does the wash-sale rule apply to my spouse’s IRA accounts?

The wash-sale rule applies across all your accounts, including those outside Schwab, as well as transactions in your IRA—and it the rule extends even to your spouse’s accounts. Furthermore, it’s up to you keep track of what’s happening across your various accounts.

What does the IRS rule on Wash sales mean for You?

What the IRS rule on wash sales might mean for you. Getting a tax break when you sell a losing investment—better known as tax-loss harvesting —is one of the few upsides of dumping an underperforming asset. So, you wouldn’t want to lose that tax break by falling afoul of an IRS rule governing “wash sales.”

Does a wash sale increase the basis in a Roth IRA?

The same rule applies to non-qualified distributions from a Roth IRA in that the wash sale does not increase the basis in the Roth IRA. Suppose that you own 100 shares of stock with a basis of $3,000.

What is a wash sale in a taxable account?

Wash-sale rules cover stocks, bonds, mutual funds, exchange-traded funds, and options sold in a taxable account. The IRS will consider transactions a wash sale if you repurchase the security in a different account, including an IRA or Roth IRA — even if the other account is in your spouse’s name.

Leave a Comment