Question

1. Describe 2 methods that a taxpayer can utilize to avoid the wash sale rules that minimizes the pre-tax economic effects?

Answer 1

The ability for taxpayers to deduct investment losses against capital gains can encourage many to realize losses on their stocks and securities at the end of a tax year. Taxpayers must be careful that they are not participating in wash sales when making adjustments to their portfolios or they may find their deductions disallowed.

If an investor wishes to liquidate a security and realize a loss in order to deduct it against capital gains, that investor must make sure that he or she is washing his or her portfolio clean of that position and not adding in a substantially identical position within 30 days before or after the sale.
According to the U.S. Securities and Exchange Commission, if a taxpayer buys an identical stock or security within the 30 days before or after the sale that creates the loss, then the loss is not deductible. Additionally, if the taxpayer buys a contract or option on an identical security within that same period, then his or her loss will not be deductible.

IRS Publication 550 states that, in order to avoid triggering the wash sale, an investor must also avoid buying a substantially identical position inside of his or her Traditional or Roth IRA. This is an important note because, generally speaking, losses within an IRA are confined to the IRA and cannot be deducted against capital gains, except in special circumstances. Investors who understand this may believe that wash sale rules would not apply if the substantially similar stock is sold from an account that is not an IRA and repurchased inside an IRA, but that would be incorrect.