The year-end wash trap

Education, not tax advice: rules, rates and thresholds change every year, so confirm anything you plan to act on with a qualified tax professional.

The previous lesson showed that a wash sale defers a loss rather than erasing it. Deferral is harmless when the replacement is sold in the same year. It is very much not harmless when the deferral crosses December 31, and the most painful version happens to traders who lose money.

How a loss year becomes a tax bill

Consider a trader who scalps the same ticker all year, mostly losing, with the last trades of the year looking like this:

Because each loss was repurchased inside the window, each was disallowed and rolled into the basis of the next lot, which was then sold at a loss and rolled again, all the way down the chain to the Dec 28 purchase. That final lot now carries all of the year's disallowed losses in its basis. Since it is still open on December 31, none of that loss is deductible this year.

Meanwhile, the gains along the way were all recognized (the rule never touches gains). The 1099-B might show something like: proceeds $2,400,000, basis $2,410,000, wash sales disallowed $40,000. Reportable result: −$10,000 + $40,000 = +$30,000 taxable gain, on a year in which the trader actually lost $30,000 economically, before the open position is counted.

At an illustrative 24% rate that is a $7,200 federal bill on a losing year. The loss is not gone; it sits in the basis of the open lot and will be recognized when that lot is sold clean. But the tax is due in April, and the relief comes whenever the position is finally closed without a repurchase, which might be next year against a much smaller income.

The mechanics of the trap

Three ingredients make it happen:

1. Repeated losses in the same security (or substantially identical ones), each followed by a re-entry within 30 days.
2. At least one of those positions still open on December 31, or repurchased in the first 30 days of January, which pulls a December loss into the following year.
3. Gains in the same year that would have been offset by those losses.

Ingredient 2 is the one that surprises people: a loss sale on December 27 followed by a buy on January 8 is a wash. The loss moves to next year's return.

Avoiding it without changing your strategy

There are only a few ways to be sure a year's losses in a ticker are recognized in that year:

• Be flat in that security, in every account, from the last loss sale through the following 30 days. For a December loss, that means no purchase until 31 days after the sale, which is into late January or February.
• Close out by late November if you know you will want to re-enter in December.
• Rotate to a non-identical instrument for the 31 days (a different company in the same sector, an ETF tracking a different index). This keeps exposure without keeping identity.
• Trade instruments the rule does not reach: Section 1256 contracts (next lesson) have no wash sales at all.
• The Section 475(f) election removes wash sales for covered securities. It has large trade-offs; Module 3.

None of these is "the answer". They are the menu, and the right choice depends on how you trade.

Key idea: A wash sale that crosses December 31 turns this year's loss into next year's, while this year's gains stay put. Heavy same-ticker trading with an open position at year end can produce a taxable gain on a losing year.

Checking your own exposure in December

Run this in the first week of December:

1. Export year-to-date trades from every account.
2. For each ticker with net realized losses, check whether you hold it now or bought it in the last 30 days.
3. For those tickers, calculate the disallowed amount your broker shows (box 1g on the running 1099 preview, or your wash-sale software).
4. Decide, per ticker, whether staying flat for 31 days is acceptable.

Numbers. A trader has $8,000 of realized gains in ticker X and $12,000 of realized losses in ticker Y, where Y has been repurchased inside every window and is still open. Reportable now: +$8,000 gain and $0 loss; tax at an illustrative 24% is $1,920. If Y is closed on December 5 and not re-entered until January 6 or later, the $12,000 loss is recognized: net −$4,000, $3,000 deductible against other income, $1,000 carried forward, and no tax on the gains. The difference between the two outcomes is one calendar decision.

Try it: Open your broker's tax-lot or "realized gain/loss" page and look for a "wash sale disallowed" column. Sort by it. Whatever ticker sits at the top is your year-end exposure; write down the date of your last loss sale in it and add 31 days.

Recap

• Wash-sale losses carried in an open position on December 31 are not deductible this year; gains still are.
• A December loss repurchased in the first 30 days of January moves to next year's return.
• Same-ticker overtraders can owe tax on a losing year; the loss returns only when the chain is closed clean.
• Options: go flat for 31 days, close by late November, rotate to a non-identical instrument, use 1256 contracts, or consider 475(f) with its trade-offs.
• Audit your disallowed-loss column in early December, not in April.