Beware of The Wash Sale Rules With Your Year End Planning.

In my blog of October 9, “Time To Plan Ahead To Minimize Taxes on 2007 Capital Gains,” I wrote about the advantages of selling your stocks with losses to offset the capital gains from the stocks you are selling at a profit. However, investors who use this strategy should be careful not to violate what are known as the “Wash Sale Rules.”

The Internal Revenue Service considers a sale to be a “Wash Sale” when a security is sold at a loss and then, within 30 days, the seller buys back the same stock or something “substantially similar.” For example, say you have a loss on Ford Motor Company stock that you sell on December 1 to use the loss to offset other capital gains. However, if you buy back Ford Motor Company stock before December 31, then you are not allowed to take the loss on the Ford Motors stock you sold. The loss you can’t take is added to the basis of the new Ford Motors stock and this total now becomes the cost basis of your new Ford Motor stock.

If all this sounds confusing, that’s because it is. And, adding to the confusion, is the fact that the rules defining “substantially identical” are not very clear. Buying back the same security as in the Ford Motor Company example clearly violates the wash sale rule. But, turning around and buying the stock of a different automaker would be okay.

This is another example of how tax laws can be very complicated. But, at least beware of this trap if you are thinking of selling a stock at a loss and buying it back within 30 days.