Can You Clean Up Your Holdings Without Wash Sales?

Plan your tax plays carefully.


With the recent precipitous decline in stock markets, many investors have found themselves holding a portfolio worth less than they originally paid to buy the shares.

Obviously, this is not a fun position to be in, but that doesn’t mean it can’t present an opportunity. There are, however, some important rules to understand if you're going to maximize the outcome from an unrealized or "paper" loss in an investment.

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What is the wash sale rule? The wash sale rule is a rule in the tax code that postpones the tax benefit of a loss in an investment if you buy back the same investment within 30 days of selling it. This requires you to sell the new shares before you are able to take the tax write-off from the sale at a loss.

Costs and risks. Commission and trading costs are the first and most obvious costs associated with selling shares that are below their acquisition cost basis. There would also be trading costs associated with repurchasing shares after the initial sale.

There are several options available to investors who wish to benefit from this kind of tax deduction.  One approach would be to sell the shares at a loss and simply wait 31 days to buy them back. But it’s possible that if the stock rebounds, you could miss the upside. If you simply hold onto the stock, you have exposure for a rebound, but no tax deduction from the drop in price. Finally, if you sell the stock then buy it back immediately, you realize the loss but need to wait until you eventually sell it to get the tax deduction. A simple alternative to these choices would be to sell your shares in ABC Corp. and buy shares in its closest competitor, XYZ Corp. However, this is not exactly the same exposure, so it's possible that ABC moves back up faster than XYZ. Then, of course, you also have incurred the costs associated with the trading.   

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An alternative approach. If, instead of buying ABC Corp. or XYZ Corp., you were to use an index tracking the sector or industry as a whole, you'd have less concentration risk associated with the individual component companies. Talk to your advisor about how to integrate index-based strategies into your tax planning.

Tax-sensitive investors can take advantage of share-price declines and potentially enhance their effective after-tax returns through some careful pre-planning.

Bottom line. Market declines of the speed and magnitude of the one we've had in the past several weeks are an unfortunate reality of investing in stocks. However, there are some smart strategies to be employed that can offer substantive benefits versus simply "holding on and hoping for the best."

Timothy R. Lee, CFP®, is a managing director and cofounder of Monument Wealth Management in Alexandria, Va., a full-service investment and wealth management firm. Monument Wealth Management is backed by LPL Financial, an independent broker-dealer and Registered Investment Advisor, member FINRA/SIPC. Monument Wealth Management has been featured in several national media sources over the past several years. Follow Tim and Monument Wealth Management on their blog Off The Wall, on Twitter at @MonumentWealth, and on their Facebook page. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for individuals. To determine which investment is appropriate, please consult your financial advisor prior to investing. All indices are unmanaged and may not be invested in directly.