The loss from the sale or disposition of stock or options is not deductible if, within a period beginning 30 days before or 30 days after the sale that generated the loss (a 61 day window), the investor acquires substantially identical shares or contracts or acquires a contract or option to buy substantially identical stock. (IRS Publication 550, page 56)
Wash sales ONLY apply to losses. Therefore, if there is a gain on the disposition of stock or options, by definition there is no wash sale.
Basis - the basis of the newly acquired stock or option that triggered the wash sale is INCREASED by the disallowed loss.
Holding period - the holding period begins for the new stock or options on the same day as the securities sold.
These are complicated calculations which are exacerbated when options are exercised or assigned during the course of a trade.
Congress enacted the wash sale rules to curb abuses by large investors in taking a loss on a stock and then turning around and buying the same stock back. Essentially a timing issue, the investor receives a large tax benefit but still holds the stock.
It is my opinion that the wash sale rules are - as is most of the tax code - too complex for the average investor and that a threshold amount should be established for lower income levels.
Planning for the Wash Sale rule:
• What are “substantially identical” securities?
This is basically a facts and circumstances determination. The purchase of another company’s stock in the same industry is not considered substantially identical. However, the purchase of a call on the same stock would be.
However, the purchase of the iShares Financial Services Index ETF (IYG) would be similar in characteristics but would not qualify as substantially identical to the SPDR Financial Select Sector ETF (XLF).
• Trading timeframe
Literal adherence to the rules is always an alternative. Simply wait 31 days before purchasing the same security again. This makes sense if the stock has dropped and earnings will be reported the following month. But it only really matters in December.
• Selling a put?
Good thinking! Publication 550 seems to describe the triggering of a wash sale with the purchase of stock or an option, ie, a call. However, the Internal Revenue Code, Sec 1091(a) states that if “the taxpayer has acquired ... or has entered into a contract or option so to acquire, substantially identical stock or securities ...” then no deduction shall be allowed. Further, the IRC goes on to say that stock or securities “include contracts or options to acquire or sell stock or securities” which clearly rules out the purchase of a call or the sale of a put.
• Related parties
If your spouse or an entity which you control repurchases loss securities within the 61 day window, a wash sale is created. With regard to the spousal transaction, presumably this is true even if you are married filing separately or you reside in a non-community property state and the wash sale is triggered with separate funds.