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IRA Wash Sales Can Have Severe Consequences

Published: December 11, 2012
Tagged: Trader Taxes, Wash Sales

Wash Sale Headache

Yes! You read that correctly: Wash sales in an IRA can have severe consequences! This often-overlooked part of the IRS wash sale rules must not be ignored by active traders and investors.

In this post I’ll explain the IRS rules and their effects and answer questions about required reporting. Plus, I'll outline strategies for IRA wash sales and highlight how TradeLog software handles these adjustments.

The rules.

IRS publication 550 states: "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…. 4.) Acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA."

For many years the rules were not as clear when it came to IRAs, but that changed with Revenue Ruling 2008-5. In that ruling, the IRS identified what must result when a wash sale occurs because of an IRA trade: "The loss on the sale of the stock or securities is disallowed under section 1091 of the Code, and the individual’s basis in the IRA or Roth IRA is not increased by virtue of section 1091(d)."

What exactly does this mean?

Unlike normal wash sales, IRA wash sales disallow the initial loss without a resulting adjustment to the cost basis of the replacement shares.

Here is a comparison to help understand the difference between normal wash sales and those in an IRA:

A Typical Wash Sale:

  • You own 100 shares of XYZ with a basis of $2,000. (In a taxable account.)

  • You sell 100 shares of XYZ on December 10 for $1,000. (Resulting in a $1,000 loss.)

  • You buy 100 shares of XYZ on December 11 for $500. (In a taxable account.)
This is a wash sale and you cannot deduct the loss of $1,000. However, you can add the loss of $1,000 to the new purchase price of $500, creating a basis of $1,500.

A Wash Sale in an IRA:

  • You own 100 shares of XYZ with a basis of $2,000. (In a taxable account.)

  • You sell 100 shares of XYZ on December 10 for $1,000. (Resulting in a $1,000 loss.)

  • You buy 100 shares of XYZ on December 11 for $500. (In a non-taxable IRA.)
This is a wash sale and you cannot deduct the loss of $1,000. In addition, you CANNOT add the loss of $1,000 to the new purchase price of $500! The loss is gone forever.

The bottom line is:
Wash sales that happen in an IRA permanently disallow actual losses that occurred in your taxable account.

Questions about IRA wash sales answered.

Q. If I sell a security in my IRA and then purchase shares of the same security in my taxable account within 30 days, does this trigger a wash sale?
A. No. IRA trades can trigger a wash sale in a taxable account, but not the other way around.

Q. Since brokers do not provide 1099-B for my IRA, how does the IRS know if there was a wash sale?
A. It’s called an audit. The IRS requires tax payers to make necessary wash sale adjustments no matter if they were reported on a broker 1099-B. If you fail to report IRA wash sales and your tax return is flagged for review, you may face tough penalties!

Q. Am I required to report my IRA trades to the IRS?
A. No. However, you are required to report the wash sale adjustments that occur in your taxable account, including those that are triggered by IRA trades. You also must keep accurate personal records, including wash sale adjustments made for IRA trades. This way, if you are audited, you have the necessary documentation to support your filing.

IRA wash sale strategies.

Because of the extremely negative effect of IRA wash sales, many traders avoid trading the same securities in their IRA as they do in their taxable accounts. If you do trade the same securities in both accounts, you may want to be extra mindful of losses that occur in your taxable account. When a loss occurs, you might avoid buying more shares of that security in the IRA for 31 days. Keep in mind, however, the wash sale period starts 30 days BEFORE the loss occurs. So you may have already incurred a wash sale with a previous purchase!

Normally you only need to be concerned about wash sales at year-end. However, wash sales in an IRA can hurt your taxable gains and losses all year long. Don’t forget, the IRS also says that trades in your spouse’s accounts must be considered for wash sales, you must account for those as well. Broker 1099-B reporting does not include these necessary wash sale adjustments. That is why active traders and investors use tools like TradeLog./p>

How TradeLog Software handles IRA wash sales.

TradeLog software has been accurately reporting wash sales in taxable accounts for over twelve years. Version 9.3 of TradeLog now introduces full support for wash sales in IRA accounts. TradeLog users setup all accounts, taxable and non-taxable, in the software. Trade history is then imported and maintained for the tax year. When generating tax reporting, TradeLog adjusts for wash sales that may occur as a result of IRA trades and makes necessary entries on the tax reporting. In addition, TradeLog provides reports with totals for wash sales that have been permanently lost due to IRA trades.

IRA wash sales present a huge challenge for many traders. By being aware of the repercussions, you can make careful decisions about what securities you trade in which account, and when. In addition, you can use TradeLog to make all of the necessary adjustments for reporting and to track wash sales in all of your accounts.

Please note: This information is provided only as a general guide and is not to be taken as official IRS instructions. Cogenta Computing, Inc. does not make investment recommendations nor provide financial, tax or legal advice. You are solely responsible for your investment and tax reporting decisions. Please consult your tax advisor or accountant to discuss your specific situation.