FINRA Series 7Investment Information and Suitable RecommendationsHard
A client sells 100 shares of XYZ stock for $5,000 on March 1st, incurring a capital loss of $1,500. On March 20th of the same year, the client buys 100 shares of XYZ stock. What is the tax implication of this transaction?
- AThe $1,500 capital loss is fully deductible in the current tax year.
- BThe client must pay a penalty for violating IRS trading rules.
- CThe $1,500 capital loss is disallowed, and the cost basis of the new shares is adjusted to reflect the loss.
- DThe $1,500 capital loss can be carried forward indefinitely.
Show answer & explanationAnswer & explanation
Correct answer: C. The $1,500 capital loss is disallowed, and the cost basis of the new shares is adjusted to reflect the loss.
This scenario describes a wash sale. The wash sale rule dictates that if an investor sells a security at a loss and repurchases a substantially identical security within 30 days before or after the sale, the loss is disallowed. Instead, the disallowed loss is added to the cost basis of the newly acquired shares.
Why the other options are wrong
- A. The loss is not fully deductible due to the wash sale rule.
- B. There is no penalty, but the tax treatment of the loss is affected.
- D. While capital losses can be carried forward, this specific loss is disallowed and used to adjust basis, not directly carried forward as a standalone loss.
Wash Sale Rule
An IRS rule that disallows a loss on the sale of a security if a substantially identical security is purchased within 30 days before or after the sale.
- The 61-day period includes 30 days before, the day of, and 30 days after the sale.
- Disallowed losses are added to the cost basis of the newly acquired shares.
- Applies to buying back the same security, options, or convertible securities of the same issuer.
Memory trick: Don't WASH your LOSSES, or they'll STICK to your new shares.