7538 / What effect does a wash sale have on the replacement stock or securities obtained in the sale?

As part of a scheme to postpone the recognition of an economic wash sale loss, rather than disallow it permanently, the IRC provides that both the tax basis and holding period of the replacement stock or securities are to be adjusted. Specifically, the tax basis of the replacement stock or securities is deemed to be equal to the tax basis of the stock or securities disposed of in the wash sale, increased or decreased, as the case may be, by the difference (if any) between the price at which the property was acquired and the price at which the substantially identical stock or securities were sold or otherwise disposed of. This generally has the effect of adding the amount of the unrecognized loss to the cost basis of the replacement stock or securities.¹ The loss is therefore deferred, not eliminated forever. It can be recognized when the stock or securities are sold or exchanged in a transaction that is not a wash sale.

Where a taxpayer sold stock or securities for a loss and acquired substantially identical stock or securities within a traditional IRA or Roth IRA within the 61-day period, the IRS found a wash sale had occurred. In this case, the taxpayer’s basis in the traditional IRA or Roth IRA was not increased by virtue of IRC Section 1091(d). ²

Furthermore, the investor’s holding period in the stock or securities disposed of in the wash sale is “tacked” (i.e., added) onto the holding period in the replacement stock or securities.³

Where identical quantities of stock or securities are sold and replaced in a wash sale, there is little problem in applying the rules discussed above. But where unequal quantities are sold and replaced or where sales and/or replacements are made in multiple lots (or transactions), the stock or securities sold and the replacement stock or securities must be matched on a chronological basis (beginning with the earliest loss and earliest replacement) before the rules can be properly applied.⁴

Example: On March 1, Ms. Whalen sells 1000 shares of X stock (lot A) at a loss of $10,000 and a second lot of 1000 (lot B) on March 2 at a loss of $25,000. On March 10, Ms. Whalen purchases 1000 shares of X stock (lot C). This purchase will result in the nonrecognition for income tax purposes of the $10,000 loss on lot A and an increase of $10,000 in the tax basis of the replacement stock (lot C). In addition, the holding period of lot C will include the holding period of lot A (i.e., the holding period of lot A will be “tacked” onto the holding period of lot C).

If, on March 20, Ms. Whalen purchases another lot (lot D) of 1000 shares of stock X, the $25,000 loss on the sale of lot B will not be recognized for income tax purposes. The tax basis of lot D will be increased by $25,000, and the holding period of lot B will be tacked onto the holding period of lot D.