Tax Experts
What Happens to Your Tax Benefit When You Violate the "Wash Sale" rule?
By Kevin McCormally, Editorial Director, Kiplinger.com
April 1, 2008
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Q: I bought into Dodge and Cox International Fund (DODFX) for $100,000 on June 14, 2007. The was the first time I have ever gone into the markets, but the investment seemed secure based on plaudits I read in Kiplinger's about Dodge & Cox.
This represented the bulk of my life's savings; I am 64.
The market started declining, so on August 16, 2007, I pulled everything out of the account. After a few weeks, the market started seemed to find an upswing and I re-invested the money on September 17, 2007.
The markets started falling again toward the end of the year , then I received the year end dividends, gain distributions, etc. When the market tumbled in the new year, I again pulled everything out of the account.
When I went to complete my taxes, I learned that I can't deduct the loss, as it was a "wash."
What gives? I still have to pay taxes on the dividends I received, but I can't claim the investment loss? Is there anyway to compensate for this loss or have I just learned a pretty expensive lesson? -- Frank V.
Kevin's Answer:
Before turning to the tax question, a brief comment about the investing lesson you've been taught the hard way. It is VERY risky to try to time the market, especially considering the increased volatility we have seen lately. And timing the market is what you're doing when you move in and out over short periods of time based on short-term results.
You are correct that we at Kiplinger like Dodge and Cox International . . . as a long term investment. Although you had a loss both times you invested (and sold) in 2007, investors who were in the fund for the entire 12 months of 2007 enjoyed an 11.71% return. In 2006, the 12 month return was 28%; in 2005, 17%.The average annual return for the five years ending December 2007 was 27%.
Based on your comments, I assume that after selling for a loss on August 16, you repurchased shares prior to September 17. If so, you violated what's called the "wash sale" rule, which prohibits the deduction of a loss on the sale of an asset if, within 30 days before or after the sale, you purchase a substantially identical asset. Buying shares in the same fund certainly qualifies.
But, you don't lose the tax-benefit of the loss forever. Instead, you increase your basis in your new shares by the amount of the denied loss. That way, when you ultimately sell the new shares, which you did in January, the higher basis effectively increases your loss by the same amount you were denied reporting on your 2007 return. You'll get the tax-saving power of the loss when you file your 2008 return next spring. I hope that by then you have some healthy gains to report, too!
Good luck.
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