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Don't Be Caught Red-Handed By The Wash Sale Rule

It often makes sense to "harvest" capital losses from securities transactions to offset capital gains. Any losses that exceed your gains can offset up to $3,000 of ordinary income for the year.

But not all investment losses are deductible. Under the "wash sale rule," a capital loss is disallowed if you acquire substantially identical securities within 30 days of the sale. This rule often trips up unwary investors.

When are securities "substantially identical?" The definition is murky, but stocks and bonds of different companies are not substantially similar. However, buying and selling shares of mutual funds within the same family could trigger the rule.

Fortunately, it's relatively easy to avoid making wash sales. You simply can wait more than 30 days to acquire substantially identical securities. Or if you want to pounce now on a particular offering, you could do that and wait more than 30 days to sell the original shares.

Be careful not to get boxed in by the wash sale rule at the end of the year. Allow yourself enough time to sell your shares.

If a loss is denied, at least there's a silver tax lining: The amount of the disallowed loss is added to the basis of the new securities, and that will have the effect of decreasing your taxable gain or increasing your deductible loss on a future sale.

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This article was written by a professional financial journalist for The Dover Group and is not intended as legal or investment advice.

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