How Taxes Are Calculated on Investments

The following is a transcript of an interview with paralegal Adriana Pedraza and attorney Jonathan Mishkin. In this interview, they discuss how taxes are calculated on investments with a focus on the wash sale rule.

Video Transcript:

Adriana: Thanks for joining Jonathan Mishkin, a trusted expert in tax law and tax controversy. I’m your host and Jonathan’s paralegal, Adriana Pedraza. Today, Jonathan will talk about taxes on investments. Hello, Jonathan, how are taxes calculated on investments?

Jonathan: Hi, Adriana. What we’re going to be talking about today is when investors try to time sales and purchases of the same security to create losses. In essence, what we’re talking about today is something called the wash sale rule. That means when you sell a security at a loss and buy a substantially identical security within 30 days before, or 30 days after such sale, the loss is going to be disallowed for current income tax purposes.

What’s very key is what I said in that sentence, the wash sale rule applies for 30 days before and 30 days after the transaction. So, you have really a 61-day window. A lot of people don’t understand that. And what they’re talking about is, is that you’re selling stock X and basically repurchasing stock X or something almost identical to stock X. That’s what we’re looking for here, it’s churning of stocks. So, what ends up happening is you don’t get to recognize the loss, you add the loss to your cost basis. So, in a way, they’re letting you not recognize the loss now, but waiting for you to fully cash out in the future.

It’s important to know that the wash sale rule is not a taxable calendar year analysis. I have been asked ‘What about if I make sales or purchases in December in January, and I straddled tax years?’. Section 1091 of the Code that deals with wash sale rules, does not care about calendar years, it looks literally 30 days back and 30 days forward.

Another question that I’ve been asked is, is this limited to one investment account so I could just open different accounts and do different things? And the answer is no. That would be too easy of a loophole. If you read these wash sale rules in Section 1091 in the regulations, it’s a per investor rule, not a per account. It’s very similar to trying to circumvent a rule like, say the $10,000 cash rule where you have to bank report by doing a series of $9,000 transactions, you can’t get around these rules by spreading yourself out.

So, selling shares from one of your accounts and buying them in another will get amalgamated. And brokers are now required, I believe they’re required to track wash sales, and include that in the 1099s that they send you. However, if you have different accounts with different custodians, the law actually says you’re responsible for tracking that because the two custodians wouldn’t know.

The last thing I would mention is what if you repurchase the securities, you’ve sold them but then you’ve bought them inside a retirement plan. It’s not only as the loss disallowed, you’re penalised inside your IRA by not getting the basis increase, because it’s a deferred vehicle. So, what I’m trying to communicate to everyone because the stock market has been going up quickly has been going down at times. You have to be careful with your advisors when you’re buying and selling the same stock or very similar stock that you don’t find yourself caught within this wash rule.

Adriana: Okay, thank you, Jonathan. If you need assistance with tax planning or tax controversy settlements, please log on to our website at www.jmishkinlaw.com.