As we approach the end of the year, it is very important to consider tax rules such as the Wash Sale Rule. If you have day traded this year, you have likely incurred a wash sale at some point. This could have serious implications for some of you, so listen up. Here is an example of what can happen if you do not pay attention to this rule: Robinhood Trader May Face $800,000 Tax Bill
If you are not familiar with how the Wash Sale rule works, it is essentially a rule that prevents investors from selling a security for a loss then quickly (within 30 days) reentering the position and writing off the loss on their taxes while maintaining their position in the security. According to Investopedia, “A wash sale occurs when an investor sells or trades a security at a loss, and within 30 days before or after, buys another one that is substantially similar.” Substantially similar is not explicitly defined by the IRS, but could refer to things like preferred stock in the same company or options contracts. So, whenever you exit a position at a loss and reenter a substantially similar position within 30 days, a wash sale is triggered and that loss is now disallowed. However, your cost basis increases (CB = realized loss + cost of repurchased security), so if you continue trading the security and make money, you can eventually erase the net loss. This may be difficult to understand without examples, so I reccomend you read the articles I have linked in this post.
If you are a long term investor or swing trader, you may be interested in tax loss harvesting. It is basically what the IRS is trying to prevent with the wash sale rule, but there are ways around it. If you want to try one of the tax loss harvesting strategies I will link to, you have until tomorrow, November 30th 2021 to take action. Wash Sales and Tax Loss Harvesting
Some brokers will mark wash sales automatically on your statements, but not all brokers will. You need to carefully review your trades and make sure you are not carrying over large disallowed losses into the new year, especially if you tend to frequently trade the same tickers.
Here is an article about wash sales geared specifically towards Day Traders: Wash Sales / IRS Wash Sale Rule
If you trade out of an IRA and another brokerage account, there are additional and somewhat complicated rules that also apply. The above article touches on this topic as well.
Note: The Wash Sale rule does not apply if you file taxes as a day trader and elect to use MTM (Mark to Market) accounting. You will only be approved for this if you are a full time trader and have made a significant number of trades consistently throughout the year. Ask your CPA for more information on this.
Disclaimer: I am not a CPA. This is not tax advice. We do not give tax advice on this sub. Consulting with a CPA is highly recommended, as overly complicated US tax code is even further complicated when you are a trader.