A Sneaky New Twist on the Wash-Sale Rules

WHEN YOU SELL a bad securities investment, the one saving grace is that you can at least claim a capital loss deduction, right?

Not necessarily. In fact, all or part of your capital loss deduction will be disallowed for federal income tax purposes if the dreaded wash-sale rule applies. And thanks to some recent IRS guidance, you now have to worry about IRA transactions triggering a wash sale problem, too. Here's an update on how the wash-sale rule works:

When you have a disallowed wash-sale loss, it doesn't just vaporize (except when an IRA is used to acquire substantially identical securities, which I'll explain later). Instead, the disallowed loss gets added to the tax basis of the acquired securities — the ones that triggered the wash-sale rule in the first place.

Then, when you sell those securities, the extra basis from the disallowed wash-sale loss either reduces your tax gain or increases your tax loss. In effect, the disallowed loss is converted into a "built-in loss" that will be taken into account when you sell the substantially identical securities. By the same logic, your holding period for the substantially identical securities is increased by the period you held the securities for which the loss was disallowed.