Year-End Moves: Be Aware of the Wash Sales Rule

If you are looking to upload some of your losing stocks and take the losses for the tax purpose in the last week of 2006, you should keep in your mind the so-called wash sales rule. According to IRS Publication 550 (2005), you can't deduct losses in a wash sale, which "occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale" you 

1. Buy substantially identical stock or securities
2. Acquire substantially identical stock or securities in a fully taxable trade
3. Acquire a contract or option to buy substantially identical stock or securities 

The rule also prohibits your loss deduction even if "your spouse or a corporation you control buys substantially identical stock" after you sell it.  

There's no clear definition of what "substantially identical" stock or security is, but stock issued by one company definitely falls into this category. This means you can't sell a stock or mutual fund and take a loss before January 1st, and buy back the same stock or mutual within 30 days after the sale. Stocks issued by different companies, however, may not be considered as "substantially identical" even though they are in the same category or same industry. Therefore, it's safe, for example, to sell Lucent, claim your losses, and buy Nortel within 30 days. For mutual funds, it may be a little tricky to determine what are "substantially identical". According to a SmartMoney article, you should be careful if you sell one S&P index fund with losses and buy another S&P index fund within 30 days.

For more information about wash sales rule, check IRS website.  

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