Clarifying Rules about Wash Sales Related to Dividend Reinvestments

[GoldenBear17]

Please tell me if I have the following accurate.

Let's say you buy some stock in your taxable account (We'll call this Lot 1). You get paid dividends a few times on that stock over time which are automatically reinvested (Lots 2, 3 and 4). Then, much later, you buy a new lot of that same stock (Let's call this Lot 5). Then you get another reinvested dividend on all the holding of that stock (Lot 6)..

If you sell Lot 5 sooner than 30 days after you received the reinvested dividend in Lot 6, then you have a wash sale and cannot tax loss harvest the sale of Lot 5.

However, if you sell Lot 5 and Lot 6 together in one sale sooner than 30 days after receiving the dividend in Lot 6, this is not a wash sale and you are allowed to do the tax loss harvest? In other words, if you sell the otherwise offending lot of reinvested dividends along with the main lot of stock you want to sell, it no longer disqualifies you from tax loss harvesting even if the dividends in that lot were reinvested less than 30 days before the sale?

Is there anything I'm missing?

[Hyperchicken]

Essentially yes, that is correct, if I'm following your example correctly.

The wash sale would have been partial if lot 6 is smaller than lot 5. You are not disqualified from claiming the loss entirely.

For more details, you need to read up on the concept of replacement shares.

When you sell lot 5, cost basis of lot 6 is increased by the amount of disallowed loss.

Since you sell the replacement shares (lot 6), the wash sale is irrelevant.

[retired@50]

For more details, you need to read up on the concept of replacement shares.

Here is an article on the concept of replacement shares from Fairmark.com
https://fairmark.com/investment-taxatio ... ent-stock/

Regards,

[GoldenBear17]

Essentially yes, that is correct, if I'm following your example correctly.

The wash sale would have been partial if lot 6 is smaller than lot 5. You are not disqualified from claiming the loss entirely.

For more details, you need to read up on the concept of replacement shares.

When you sell lot 5, cost basis of lot 6 is increased by the amount of disallowed loss.

Since you sell the replacement shares (lot 6), the wash sale is irrelevant.

So if I sell lot 5 and keep lot 6, I can tax loss harvest [the amount of the sale of lot 5 - the price of my shares in lot 6]? Is it the price of the shares in lot 6 when they were purchased in the dividend reinvestment? Or at the time of the sale of lot 5?

And when the cost basis of lot 6 is increased by the amount of the disallowed loss, is that actually changed in my account on the broker's site? Like if this is at Vanguard, will Vanguard remove the original cost basis on lot 6 and replace it with a new higher one? Will they show the original cost basis and also what it was changed to? Or is this increase in cost basis something I just have to remember myself going forward?

[GoldenBear17]

For more details, you need to read up on the concept of replacement shares.

Here is an article on the concept of replacement shares from Fairmark.com
https://fairmark.com/investment-taxatio ... ent-stock/

Regards,

Thank you. That's very helpful in general.

He doesn't cover the scenario though where you sell the shares that would otherwise be replacement shares. So even if you buy shares that would be replacement shares, if you sell them along with the other shares, then my understanding is that the wash sale disappears.

[increment]

Like if this is at Vanguard, will Vanguard remove the original cost basis on lot 6 and replace it with a new higher one? Will they show the original cost basis and also what it was changed to? Or is this increase in cost basis something I just have to remember myself going forward?

They are supposed to adjust the basis for you (if they managed to notice that you had a wash sale). Probably they will not bother to show your "original" basis (there could be many adjustments to the basis, and nowhere to show all those changes). If you want to verify that they have done it, you may need to keep your own set of records.

He doesn't cover the scenario though where you sell the shares that would otherwise be replacement shares. So even if you buy shares that would be replacement shares, if you sell them along with the other shares, then my understanding is that the wash sale disappears.

The accounting could be done either way.

If it's treated as a wash sale, then a capital loss is "disallowed" but that amount is added to the basis of the replacement shares. That means that the capital gain, when those replacement shares are sold, is reduced by that same amount. The end result is that the total taxable income is the same in the "wash sale detected" scenario as in the "wash sale never happened" scenario.

[rkhusky]

If you sell them together, you could still end up with a wash sale, depending on how the brokerage handles things, but they will manage the accounting and you will get your full loss. But most brokerages won’t flag a wash sale if you sell both lots together.

To completely avoid the wash sale, sell the purchased shares first, and then the next day, sell the shares that are at a loss.

[GoldenBear17]

If you sell them together, you could still end up with a wash sale, depending on how the brokerage handles things, but they will manage the accounting and you will get your full loss. But most brokerages won’t flag a wash sale if you sell both lots together.

To completely avoid the wash sale, sell the purchased shares first, and then the next day, sell the shares that are at a loss.

Why would you end up with a wash sale if you sell the lots together?

You're saying to avoid the wash sale, you sell the reinvested dividends (lot 6) first and then the main shares at a loss (lot 5) the next day? Why in that order? Also, depending on how low the price has gone it's very possible both lot 6 and lot 5 are at a loss.

I do wish you didn't have to sell them on separate days since you may have a price come up that you want to sell at. If you have to sell just the measly reinvested dividends that day, then by the next day when you sell the much larger lot, the price may have gotten worse for you. Is it actually important to not sell them together but on separate days?

[increment]

I do wish you didn't have to sell them on separate days since you may have a price come up that you want to sell at. If you have to sell just the measly reinvested dividends that day, then by the next day when you sell the much larger lot, the price may have gotten worse for you. Is it actually important to not sell them together but on separate days?

No, taking such steps to avoid the scarlet letter "W" ("wash sale" on Form 8949) is not important because in this situation having a wash sale should make no difference to your taxable income.

[rkhusky]

If you sell them together, you could still end up with a wash sale, depending on how the brokerage handles things, but they will manage the accounting and you will get your full loss. But most brokerages won’t flag a wash sale if you sell both lots together.

To completely avoid the wash sale, sell the purchased shares first, and then the next day, sell the shares that are at a loss.

Why would you end up with a wash sale if you sell the lots together?

You're saying to avoid the wash sale, you sell the reinvested dividends (lot 6) first and then the main shares at a loss (lot 5) the next day? Why in that order? Also, depending on how low the price has gone it's very possible both lot 6 and lot 5 are at a loss.

I do wish you didn't have to sell them on separate days since you may have a price come up that you want to sell at. If you have to sell just the measly reinvested dividends that day, then by the next day when you sell the much larger lot, the price may have gotten worse for you. Is it actually important to not sell them together but on separate days?

That’s only if you want to make absolutely sure there is no wash sale. You could also try to find out how your brokerage typically handles things. It’s likely that they wouldn’t flag it.

The reason they could flag it is if their computers are not programmed to recognize the situation. Even though you submit the lots together, they are processed separately. If the computer happens to sell the lot with a loss first, it might see that you had a purchase within 30 days that you still own, call it a wash sale, disallow part of your loss, and adjust the basis of the purchased shares. Then a microsecond later, the latter shares are sold, and you’ve recovered your full loss.

Or the computer could sell the recently purchased shares first and then no wash sale.

Or the computer could recognize that you submitted the two lots together, and decide not to flag a wash sale, no matter what order they are sold.

If the computer does flag a wash sale, it is only an extra couple entries on your tax return.

[Thesaints]

Two small comments:

1) the fact that reinvested dividends are involved is completely immaterial. For CG purposes, reinvested dividends = “somehow I have this money and I used it to buy XYZ”.

2) In case the brokerage splits transactions and reports a wash sale, besides filling two separate entries on 8949 ending up with the same total CG as if the was sale were not there, one can also combine the entries reported separately on 1099-B, ignore the wash sale, and write “M” in column (g) [or is it (f) ?]. Instructions are pretty clear.
The IRS is not going to come after you, I promise.

[grabiner]

If you sell them together, you could still end up with a wash sale, depending on how the brokerage handles things, but they will manage the accounting and you will get your full loss. But most brokerages won’t flag a wash sale if you sell both lots together.

To completely avoid the wash sale, sell the purchased shares first, and then the next day, sell the shares that are at a loss.

Why would you end up with a wash sale if you sell the lots together?

You might have a wash sale reported by your brokerage, but it would have no effect on your taxes.

Consider the following example:

You bought 100 shares a long time ago for $60.
Last week, you bought 100 more shares for $50.
You now sell both lots for $52.

Your brokerage reports a sale of the old lot first. When you sell the old lot, you have a wash sale and cannot deduct your loss of $8 per share, but the basis of the new lot increases to $58 per share. One microsecond later, your brokerage reports a sale of the new lot, with a capital loss of $6 per share. Your capital loss is $600, just as it would be without the wash sale rules.

[GoldenBear17]

Why would you end up with a wash sale if you sell the lots together?

You're saying to avoid the wash sale, you sell the reinvested dividends (lot 6) first and then the main shares at a loss (lot 5) the next day? Why in that order? Also, depending on how low the price has gone it's very possible both lot 6 and lot 5 are at a loss.

I do wish you didn't have to sell them on separate days since you may have a price come up that you want to sell at. If you have to sell just the measly reinvested dividends that day, then by the next day when you sell the much larger lot, the price may have gotten worse for you. Is it actually important to not sell them together but on separate days?

That’s only if you want to make absolutely sure there is no wash sale. You could also try to find out how your brokerage typically handles things. It’s likely that they wouldn’t flag it.

The reason they could flag it is if their computers are not programmed to recognize the situation. Even though you submit the lots together, they are processed separately. If the computer happens to sell the lot with a loss first, it might see that you had a purchase within 30 days that you still own, call it a wash sale, disallow part of your loss, and adjust the basis of the purchased shares. Then a microsecond later, the latter shares are sold, and you’ve recovered your full loss.

Or the computer could sell the recently purchased shares first and then no wash sale.

Or the computer could recognize that you submitted the two lots together, and decide not to flag a wash sale, no matter what order they are sold.

If the computer does flag a wash sale, it is only an extra couple entries on your tax return.

You keep referring to it as if one lot has a loss and the other not. But what if both Lot 5 and Lot 6 have a loss when you sell them?

[rkhusky]

That’s only if you want to make absolutely sure there is no wash sale. You could also try to find out how your brokerage typically handles things. It’s likely that they wouldn’t flag it.

The reason they could flag it is if their computers are not programmed to recognize the situation. Even though you submit the lots together, they are processed separately. If the computer happens to sell the lot with a loss first, it might see that you had a purchase within 30 days that you still own, call it a wash sale, disallow part of your loss, and adjust the basis of the purchased shares. Then a microsecond later, the latter shares are sold, and you’ve recovered your full loss.

Or the computer could sell the recently purchased shares first and then no wash sale.

Or the computer could recognize that you submitted the two lots together, and decide not to flag a wash sale, no matter what order they are sold.

If the computer does flag a wash sale, it is only an extra couple entries on your tax return.

You keep referring to it as if one lot has a loss and the other not. But what if both Lot 5 and Lot 6 have a loss when you sell them?

Doesn’t matter. What matters is one lot is sold for a loss and another lot is purchased within +-30 days of that sale and is still held.

If both lots were purchased within 30 days of each other, both have losses, and they are sold within 30 days of both purchases, then you can’t avoid a wash sale by selling individually. Some brokerages might not flag a wash sale if you submit the sales together in one transaction, but some might.

[Rocinante Rider]

If both lots were purchased within 30 days of each other and both have losses, then you can’t avoid a wash sale by selling individually.

Didn't you mean to say "within 30 days of the sale," not "within 30 days of each other"?

[rkhusky]

If both lots were purchased within 30 days of each other and both have losses, then you can’t avoid a wash sale by selling individually.

Didn't you mean to say "within 30 days of the sale," not "within 30 days of each other"?

Actually I should have said both. Corrected. Thanks.