In this year’s tumultuous stock market, many taxpayers may have realized losses from the sale of stock. In considering the deduction of these losses for tax purposes, it is commonly known that such losses:

(a) are treated as capital losses,

(b) first can be utilized to offset capital gains of a similar type (short-term (i.e., stock held for one year or less) capital losses against short-term capital gains, and long-term (i.e., stock held for more than one year) capital losses against long-term capital gains),

(c) next can be utilized to offset capital gains of a different type, and

(d) then can be utilized to offset up to $3,000 of ordinary income (with any excess capital losses able to be carried forward to future tax years).

IRS Code Section 1091

Another perhaps less well-known rule that can affect the tax deduction of losses from the sale of stock is the wash sale rule, enacted under Internal Revenue Code Section 1091.

The general concept of the wash sale rule is that if you claim a loss from the sale of stock, you should have changed your economic position in the stock. If you sell the stock, but shortly before the sale or shortly after the sale you separately acquire the same stock (or, as described below, under Internal Revue Code Section 1091, “substantially identical” stock), you in effect have not changed your economic position in the stock and should not be allowed to claim a tax loss. Have you really sold the “stock” under these circumstances?

Specifically, Internal Revenue Code Section 1091(a) provides in part, “In the case of any loss claimed to have been sustained from any sale or other disposition of shares of stock or securities where it appears that, within a period beginning 30 days before the date of such sale or disposition and ending 30 days after such date, the taxpayer has acquired (by purchase or by an exchange on which the entire amount of gain or loss was recognized by law), or has entered into a contract or option so to acquire, substantially identical stock or securities, then no deduction shall be allowed under section 165 unless the taxpayer is a dealer in stock or securities and the loss is sustained in a transaction made in the ordinary course of such business”.

There are several important terms under this statutory language of Internal Revenue Code Section 1091(a).

First, the wash sale rule applies to “securities” generally, and not just to “stock”. In addition, the last sentence of Internal Revenue Code Section 1091(a) states, “For purposes of this section, the term ‘stock or securities’ shall, except as provided in regulations, include contracts or options to acquire or sell stock or securities”.

Second, the wash sale rule applies both “30 days before the date of such sale or disposition” and “30 days after such date”. While persons may understand the “30 days after” aspect of the wash sale rule, they appear to be less cognizant of the “30 days before” aspect of the wash sale rule. Thus, with respect to a loss from a sale made on May 15, 2025, acquisitions within both the ”April 15, 2025 – May 15, 2025” time period and the “May 15, 2025 – June 14, 2025” time period potentially are within the scope of the wash sale rule.

Third, the term, “taxpayer”, is broadly applied by the Internal Revenue Service. It views acquisitions not only by you, but also by your spouse or by a corporation that you control, as potentially within the scope of the wash sale rule.

Fourth, the exception that Internal Revenue Code Section 1091(a) does not apply if “the taxpayer is a dealer in stock or securities and the loss is sustained in a transaction made in the ordinary course of such business” in effect means that the wash sale rule applies to investment transactions, and not to “dealer/ordinary course of business” transactions.

Fifth, perhaps the most important term under Internal Revenue Code Section 1091(a) is “substantially identical”; have you acquired “substantially identical stock or securities” with respect to the “stock or securities” that you sold at a loss? The Internal Revenue Service views the issue of “substantially identical” as a “facts and circumstances” analysis. The Internal Revenue Service states that while the stocks or securities of one corporation generally are not considered “substantially identical” to the stocks or securities of another corporation, they may be “substantially identical” in some cases, such as possibly the stocks and securities of the predecessor and successor corporations in a reorganization. In addition, the Internal Revenue Service states that while the bonds or preferred stock of a corporation generally are not considered “substantially identical” to the common stock of such corporation, they may be “substantially identical” in some cases, such as possibly bonds or preferred stock convertible into common stock of the same corporation (including that preferred stock is “substantially identical” to common stock if the preferred stock is convertible into common stock, has the same voting rights as the common stock, is subject to the same dividend restrictions, trades at prices that do not vary significantly from the conversion ratio, and is unrestricted as to convertibility). An interesting, but generally unresolved, question is how the issue of “substantially identical” should apply to mutual funds or exchange-traded funds (“ETFs”).

“Substantially identical” does not require that the same amount of “substantially identical stock or securities” be acquired and sold to trigger the application of the wash sale rule. The income tax regulations under Internal Revenue Code Section 1091 (Regulation Section 1.1091-1) describe how to specifically apply the wash sale rule in this specific situation of unequal amounts of “stock or securities” that were acquired and sold. When the amount of “stock or securities” acquired is less than the amount of “stock or securities” sold, the “stock or securities” acquired will be matched in accordance with the order of their acquisition (beginning with the earliest acquisition) with an equal number of the shares of “stock or securities” sold. On the other hand, when the amount of “stock or securities” acquired is more than the amount of “stock or securities” sold, the “stock or securities” sold will be matched with an equal number of the shares of “stock or securities” acquired in accordance with the order of acquisition (beginning with the earliest acquisition) of the “stock or securities” acquired.

A key point is that the wash sale rule ultimately can have a deferral, rather than a disallowance, effect. This point arises because the amount of loss subject to the wash sale rule generally is added to your tax basis in the acquired “stock or securities”. As a result, when the acquired “stock or securities” are ultimately sold, the taxable gain from such sale potentially would be correspondingly reduced. In addition, the “holding period” (possibly relevant to convert short-term capital gain into more “favorably taxed” long-term capital gain) for the acquired “stock or securities” can include the “holding period” of the sold “stock or securities”.

Notwithstanding the consequences described in the preceding paragraph that can somewhat reduce the adverse impact of the wash sale rule, it can be very frustrating to believe that you are realizing a tax benefit when you sell stock at a loss (including with the intention of offsetting capital gain income), but then be denied recognition of such tax loss in the taxable year because of the wash sale rule. Please keep in mind the wash sale rule as an important factor in your investment decision-making.

If you have any questions concerning the wash sale rule, please discuss this subject with your advisers.

Note – “One Big Beautiful Bill Act”

On May 22, 2025, the House of Representatives approved the “One Big Beautiful Bill Act”. While the legislation makes significant changes to Medicaid and the Supplemental Nutrition and Assistance Program (often referred to as “food stamps”), and addresses a variety of other issues (including funding for construction of a U.S.-Mexico border wall, hiring of Border Patrol agents and Immigration and Customs Enforcement officers and investigators, and creation of a “Golden Dome for America” missile defense shield), it also has a significant impact on tax matters. Most significantly, the legislation would make permanent (otherwise due to expire at the end of year 2025) the individual income tax and estate tax cuts enacted in year 2017. In addition, the legislation would increase the standard deduction (through year 2028) for individual filers to $16,000 and for joint filers to $32,000, the child tax credit (through year 2028) to $2,500, and the cap on the deduction of state and local taxes to $40,000 (subject to phase out at certain higher incomes), generally exempt (through year 2028) tips and overtime from income taxation, and reduce various “clean energy” tax credits. Of course, the “One Big Beautiful Bill Act” is not yet enacted law; tax legislation also needs the consent of the Senate and approval of the President. However, as an indication of what the Republican-controlled Congress and President Donald Trump ultimately may support, it is useful for taxpayers to review for tax planning.

If you have any questions concerning the “One Big Beautiful Bill Act” or any other issue concerning tax legislation, please discuss these subjects with your advisers.

If you wish to discuss any of the above, find Pen Pal Gary’s contact info here.

Disclaimer: please note that nothing in this article is intended to be, or should be relied on as, legal advice of any kind. Neither LHBR Consulting, LLC nor Gary Stern provides legal services of any kind.