Covered call writing and put-selling involve the buying and selling of stocks and options. When executed in non-sheltered accounts, taxable events are created. Since the BCI community is populated with savvy investors, the topic of wash sales has come up frequently and some have used the term wash trading interchangeably with wash sales. This article will discuss the differences between the two terms.
A wash sale loss is not deductible. A wash sale occurs when you sell a stock for a loss and, within 30 days before or after the trade, buy back the same stock or substantially the same stock (like an option). Stocks of one company are not considered substantially identical to those of another. For example, if you sell a stock for $35 for a loss. And then buy a $35 call option, you have a wash sale and cannot deduct the loss on the stock. In essence, the tax code considers the loss transaction and the purchase of the replacement security a “wash” so there aren’t any deductible tax benefits to offset capital gains. Wash sales apply only to losses.
Wash sales also apply to options that are substantially identical.
Wash sales are not negated if you sell a stock in one account and buy it back in another or even in the account of your spouse. A tax loss is also disallowed if the stock was sold in a sheltered account and re-purchased in a non-sheltered account and vice-versa. The IRS has all bases covered!
What happens to the loss? All is not lost
The loss gets added to the basis of the replacement security so that when you sell, that disallowed loss either reduces the gain or enhances the loss. Also, the holding period of the wash sale is added to the holding period of the replacement security which increases the chances of qualifying for more favorable long-term tax rates.
Example when there is an equal amount of shares sold and re-purchased:
- 3/1/2-15: Buy 100 x BCI @ $3000.00
- 7/1/2015: Sell 100 x BCI @ $2000.00 for a loss of $1000.00
- 7/10/2015: Buy 100 x BCI @ $2200.00
In this example, the $1000.00 loss is disallowed but added to the cost basis of the replacement shares which becomes $3200.00 ($2200.00 + $1000.00). The holding period of the disallowed loss (3/2/2015 – 7/1/2015) is added to that of the replacement shares. Had the purchase of the replacement shares taken place after the 30-day period, there would be no wash sale and the tax loss would be permitted.
***Wash sales apply to all investment accounts you own including those of your spouse.
Wash trading is an illegal process of repeatedly buying shares of stock from one broker and selling similar shares through a different broker. This leaves the impression of high volume activity despite the fact that the shares remained with the same owners. The purpose of doing this is to motivate other investors to buy shares of a stock that appears to be of great interest to the market. In essence, this is a form of price manipulation that US regulators are investigating especially as it relates to high-frequency traders.
The terms wash sale and wash trade are similar but have completely different connotations. The former relates to tax issues which impact retail investors and the latter to illegal price manipulation. Wash trading is one of the scams that should motivate retail investors to be extremely careful when it comes to buying and selling penny stocks.
This email from Kevin brought tears to my eyes
It was great to finally meet you at the Charlotte, NC AAII meeting. You did a great job, I hope your message got through.
In your presentation you mentioned writing calls for your Mom. I would like to share with you a personal story regarding covered calls and my Mom. In 1991, I suggested to my mother that she needed Long Term Care Insurance. Her response was that it was too expensive. I decided she needed it and that I would pay for it. I cooked up a lame excuse that she would be covered as extended family with my company. The premium was $ 2,500/Yr. Each quarter I wrote CCs to cover the quarterly premium and I did this from 1991 until 2012. In 2012, mom had a stroke. I found the best LTC facility for her. The monthly charge to be in the facility was $4500/month. Her LTC policy covered $3,000/month. So once again I wrote CCs calls to make up the difference. Mom died one year from the date of her stroke, but I had the peace of mind knowing that she lived her final year with the best of care and with dignity and respect, because money was not an issue because of covered calls.
I am sure you have heard similar type stories, but I wanted to share mine with you, since you have been doing this for your mom as well.
Thanks for all that you do,
Ask Alan videos and website enhancement
In the next few months we will be enhancing our website to accommodate all the new articles and videos we’ve added since our last upgrade. In preparation for this and several exciting new investment tools we are working on, we have made the Ask Alan videos available in two locations:
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Tuesday April 21st
7 PM – 9:30 PM
***Brand new seminar on selling cash-secured puts.
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The increasing chance of a Greek debt default negatively impacted the markets on Friday. Also, weakening Chinese economic growth increased the possibility of additional central bank stimulus. Thus far corporate earnings have been mixed, a bit better than I anticipated. This week’s reports:
- Standard & Poor’s Ratings Services cut the credit rating for Greece to CCC+ with a negative outlook, as S&P expects Greece’s debt and financial commitments to be unsustainable without serious economic reform
- US industrial production fell by 0.6% seasonally adjusted in March, worse than the expected 0.3% drop. Impacted by oil industry cutbacks and a stronger US dollar, industrial output contracted at an annual rate of 1% for the first quarter — the first such decline since 2009
- The National Association of Home Builders/Wells Fargo homebuilder confidence index rose to 56 in April from a revised 52 in March, the first gain in five months
- US housing starts rose a less-than-expected 2% in March to a seasonally adjusted annual rate of 926,000. Single-family units increased 4.4%, while multifamily units fell 2.5%.
- The University of Michigan consumer sentiment index rose to an April reading of 95.9 from a final reading of 94.0 in March
- US retail sales increased 0.9% in March, the biggest monthly gain in a year, but less than the predicted 1.1% increase
- Initial claims for US unemployment benefits rose 12,000 to 294,000 for the week ended 11 April
- Continuing claims fell 40,000 to 2.27 million for the week ended March 28th
For the week, the S&P 500 fell by 0.95%% for a year to date return of 1.1%, including dividends.
IBD: Uptrend under pressure
GMI: 6/6- Buy signal since market close of January 23, 2015
BCI: I am maintaining my defensive posture and favoring in-the-money strikes 2-to-1. An alternative would be to sell out-of-the-money cash-secured puts. This site remains long-term bullish and expects a resurgence of our economy in the second half of the year.
Wishing you the best in investing,
Alan ([email protected])