Surprise! Your stock loss is not deductible.

You may be considering booking stock losses due to recent market drops. Selling losers can be a great strategy when these losses can offset other gains and up to $3,000 of your ordinary income. However, there is a little-known rule called the wash sale rule that could surprise the unwary taxpayer.

Wash sales explained

If the wash sale rule applies to your transaction, you cannot immediately report a loss you take when selling a security. Per the IRS:

A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale you:

• Buy substantially identical stock or securities,
• Acquire substantially identical stock or securities in a fully taxable trade,
• Acquire a contract or option to buy substantially identical stock or securities, or
• Acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA.

Why the rule?

Many investors were selling stock they liked simply to book the loss for tax reasons. They then turned around and immediately re-purchased shares of the same company or mutual fund. If done repeatedly, shareholders could constantly be booking short-term losses on a desired company while still owning the shares in a chosen company’s stock indefinitely. Clever shareholders would even purchase the replacement shares prior to selling other shares in the same company to book the loss.

Some ideas

How does one take action to ensure the wash sales rule works to your advantage?

Check the dates. If you decide to sell a stock to book a loss this year, make sure you haven’t inadvertently acquired the same company’s shares 30 days prior to or after the sale date.

Dividend reinvestment. If you automatically re-invest dividends, you will want to make sure this doesn’t inadvertently trigger the wash sales rule.

It’s only for losses. Remember, the wash sales rule only applies to investments sold at a loss. If you are selling stock to capture gains, the rule does not apply.

Consider similar transactions. The wash sales rule applies to buying and selling ownership in the same company or mutual fund. With the exception of some common versus preferred stock of the same company, buying and selling similar – but not identical – shares does not apply to the wash sales rule.

If your loss is ever disallowed because of the wash sales rule, you can add the disallowed loss on to the cost of the new security. When the security is eventually sold in the future, the previously-forfeited loss will be part of the calculation of future gain or loss. This also includes the original stock’s holding period to help define the transaction as a short-term or long-term sale.

Originally Published: July 15, 2024 at 10:41 p.m.

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Average short interest across S&P 500 financial stocks was flat at 1.48% of shares float as of the end of June, compared to the prior month.

The S&P 500’s financial sector (NYSEARCA:XLF) was up 12.7%, as compared to the broader S&P 500 index’s rise of 17.7% since the start of the year.

The largest contributor to the index, Berkshire Hathaway (BRK.B) had a short interest of 0.77% of the total float, while the next biggest contributor, J.P. Morgan’s (JPM) short interest, stood at 0.81%.

JPM’s Q2 earnings trailed the Wall Street consensus, as the company bolstered the amount of money it sets aside for potential credit losses.

Stocks with the largest and least short positions:

Ranked by short interest as a percentage of shares float