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wash sale

What Is a Wash Sale?

We’re not talking about laundry

Say you hold an investment in a taxable account and you sell it for a loss. Can you use that loss to lower your taxes?

Yes — unless you purchase that same security (or one that is substantially identical) either 30 days before or after you sold that asset. If you did, the sale is called a “Wash Sale” and the loss is disallowed.

The Wash Sale Rule closes a tax loophole: Say you invest $10,000 in shares of XYZ Corporation and the value falls to $7,000. You want to keep your shares because you believe the stock will rise, but you’d also like to lower your taxes. So you sell your shares and immediately re-buy them. This way, you figure, you get to continue owning your shares — and you’ve collected a $3,000 tax deduction at the same time!

Sorry, but you’ve just run afoul of the Wash Sale Rule. You can’t take a deduction for such sales, yet you must still report them on Form 8949, noting them as a “Wash Sale.” (Your original cost basis is adjusted for the disallowed loss, so you’ll eventually get the tax break you’re seeking.)

If the Wash Sale Rule disallows losses incurred, why not simply avoid transactions that trigger them? Well, sometimes they are simply unavoidable — especially when you engage in periodic rebalancing as part of a comprehensive asset allocation strategy.

That’s where the Edelman Managed Asset Program® comes in. As you know, rebalancing is an integral part of EMAP. Without this crucial function, your portfolio could become overweighted or underweighted in one or more asset classes — possibly resulting in higher volatility or lower returns. To reduce the risk that such problems might occur, we periodically sell shares of one investment and buy shares of another. Ordinarily, rebalances occur infrequently, but if there were periods of volatility in the past year, there may have been occasions where we needed to repurchase shares of an investment that had been sold within 30 days — triggering the Wash Sale Rule.

In such cases, we knew we were triggering the rule, but we executed the trades anyway. Why? Because our motivation wasn’t tax savings, but to realign your assets in a manner consistent with your asset allocation. If your account is in need of rebalancing, then rebalance we will. There’s no harm tax-wise, and past results have shown that our rebalancing efforts have helped control volatility in your portfolio. To be sure, tax considerations are important, but they should never outweigh the more important objectives of your investment portfolio.

To summarize:

  1. Rebalancing can cause a Wash Sale.
  2. The disallowed loss under a Wash Sale is added back to the cost of the security. This will reduce your future taxable gains and thus lower your future taxes.
  3. The benefits of rebalancing can outweigh the nuisance of reporting Wash Sales. Never make investment decisions primarily based on taxes.
  4. The complexity of reporting Wash Sales demonstrates that you should always work with a tax advisor in the preparation of your tax return.

If you have any questions, please contact us.

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