Wash Sales and Day Trading

Question

Let's say a Day Trader buys and sells a stock on the same day and makes a loss of $1,000. Then she buys and sells the same stock the next day and makes a profit of $500. On the third day she files her taxes.

As I understand the Wash Sales rule, she cannot claim a $500 overall loss on the stock. She will need to declare a $500 profit on the stock. Because she bought a "substantially similar" (identical, actually) stock within 30 days of the loss transaction.

Am I interpreting this correctly? (I hope I'm wrong!)

Answer 1

Great question! It can be a confusing for sure -- but here's a great example I've adapted to your scenario:

As a Day Trader, you buy 100 shares of LMNO at $100, then after a large drop the same day, you sell all 100 shares at $90 for a loss of $1,000. Later in the afternoon, you bought another 100 shares at $92 and resold them an hour later at $97 (a $500 profit), closing out your position for the day.

The second trade had a profit of $500, so you had a net loss of $500 (the $1,000 loss plus the $500 profit).

Here’s how this works out tax-wise: The IRS first disallows the $1,000 loss and lets you show only a profit of $500 for the first trade (since it was a wash). But it lets you add the $1,000 loss to the basis of your replacement shares. So instead of spending $9,200 (100 shares times $92), for tax purposes, you spent $10,200 ($9,200 plus $1,000), which means that the second trade is what caused you to lose the $500 that you added back (100 x $97 = $9,700 minus the 100 x $102 = $10,200, netting $500 loss).

On a net basis, you get to record your loss, it just gets recorded on the second trade. The basis addition lets you work off your wash-sale losses eventually, and in your case, on Day 3 you would recognize a $500 final net loss for tax purposes since you EXITED your position. Caveat: UNLESS you re-enter LMNO within 30 days later (at which point it would be another wash and the basis would shift again).

Source: http://www.dummies.com/personal-finance/investing/day-trading/understand-the-irs-wash-sale-rule-when-day-trading/

Answer 2

You are correct. She cannot claim the initial loss of $1,000 on her taxes, she can only report the $500 profit.

However, the IRS does allow her to add the $1,000 loss to the basis cost of her replacement shares.

e.g.

1. Trader buys 100 shares at $100 / share.
2. Trader sells 100 shares later that day at $90/share. Loss of $1,000
3. Trader buys 100 shares the next day at $85/share.
4. Trader sells 100 shares later that day at $90/share. Gain of $500
5. Trader can add the initial $1,000 loss from #2 to the $8,500 spent in #3, for a total cost of $9,500 and a sale (#4) of $9,000, resulting in a net loss of $500.

Answer 3

Yes, an overall $500 loss on the stock can be claimed. Since the day trader sold both lots she acquired, the Wash Sale rule has no net impact on her taxes.

The Wash Sale rule would come into play if within thirty days of second sale, she purchased the stock a third time. Then she would have to amend her taxes because claiming the $500 loss would no longer be a valid under the Wash Sale rule. It would have to be added to the cost basis of the most recent purchase.