by Catherine A. Walsh, CPA, MBT

If you decide to sell a stock and the result is a realized loss, you may want to review the wash sales rules to ensure that you do not lose the deduction attributed to your loss on the security. The following article is a brief overview of the wash sales rules.

Generally speaking, you may not deduct a loss on a sale of stock if you purchase a substantially identical replacement stock within 30 days. There is a 61 day window, 30 days before and 30 days after the sale date when the wash sales rule applies. These are calendar days, not trading days. This rule applies to contracts to purchase a stock, option and mutual funds holding stocks. It sounds very straightforward, but understanding the meaning of the details is important.

Substantially identical does not include stocks of different issuers in the same industry. For example, stock issued by Wal-Mart would not be considered substantially identical to stock issued by Target. The general rule changes, however, if one stock’s value is substantially affected by the other’s value, such as in a pending merger transaction. Although there is no direct IRS guidance on the issue of mutual funds, two mutual funds with substantially the same underlying holdings, even if they are issued by different mutual fund companies, may be considered substantially identical.

In this context, replacement stock means shares that were purchased to replace shares that were sold. Defining replacement stock can be complicated. In some cases, selling by the specific identification method (communicating in writing to the custodian the precise shares that you wish to sell) might be necessary. Here are two examples:

You purchased 30 shares of XYZ on March 1, 2008. On March 20, 2008, you sold 30 shares of XYZ at a loss. This is a sale of the entire holding with no other related purchases or sales. It is not a wash sale because the shares purchased were not replacement shares.

You purchase 100 shares of ABC in the morning and another 100 shares in the afternoon of the same day. Twenty days later, you sell the morning shares. This could be considered a wash sale since the afternoon shares could be thought of as replacement shares. If, on the other hand, you had sold the afternoon shares, this might not be considered a wash sale.

If you are considering selling stock at a loss and you are not sure whether the wash sales rules apply to your specific case, consult your tax advisor.