Wash sale issue for profitable trader

[MuMiX]

Having an odd issue where as a profitable trader, because of wash sale rules, when I import my 1099B, TurboTax is saying that I owe ~1300% taxes on my profit (more than my net worth!).  I think the wash sale rule is being misapplied in my case -- here is a simplified scenario:

All trades with same ticker.

Trade 1,Bought Dec 28 2020,Sold Dec 28 2020,loss $5

Trade 2,Bought Dec 28 2020,Sold Dec 28 2020,gain $10

Trade 3,Bought Jan 5 2021,Sold Jan 5 2021,gain $10

In the above scenario, what I think should happen is that the Trade 1 shows up as a wash sale, and is rolled into trade 2, giving me a net profit of $5 for 2020.  However, what I think 1099B and/or TurboTax is doing is rolling the wash sale from Trade 1 into Trade 3, yet still charging me tax on Trade 2!

Any insights are appreciated.  Thanks all.

[hbl3973]

MuMiX,

From what I see, TurboTax is handling it correctly.  There were less than 30 days between the initial loss of the first trade and the purchase date of the third trade.  So the loss on the first trade is not allowed to be applied to the second trade as you (again) replaced the equity sold with an essentially identical one.  You have a profit of $10 on the second trade that is reported against 2020 income.  If you do not repurchase the same stock within 30 days of the Jan 2021 sale, you can then apply the $5 loss to against the gain on the third trade for a profit of $5 to report on your 2021 tax return.

[MuMiX]

Thank you for the response.  Here's another scenario.  Let's say an individual has $100k to his name at the beginning of 2020 and decides to learn how to trade.  He day trades high volume (many trades) on the same stock everyday through the end of the year into 2021.  Let's say at the end of the 2020 year he is net profit of $100k, but due to wash sale rules, his gains are 3.3 million and his losses are 3.2 million.  He is forced to pay taxes on 3.3 million with a tax burden of 1.3 million, and the 3.2 million in losses would carry forward to 2021 (and indefinitely).  The individual obviously cannot afford 1.3 million in taxes now having only 200k to his name.  The individual is also unlikely to make 3 million in gains in the next few years to offset the losses that would carry forward.  And individuals cannot carry losses backwards, so the 2021 losses could not be applied back to the 2020 gains.

Unfortunately, I am the individual.  Am I misunderstanding something or is the IRS about to force someone who made money to file bankruptcy because of a silly application of the wash sale rule?  I was aware of the wash sale rule but I didn't think it applied to profitable traders... I thought the point was to stop tax loss harvesting, and here I am just trying to pay taxes on the money I made and they won't let me.

[fanfare]

you are misunderstanding and/or reporting incorrectly.

if you are an active trader, when you close the triggering transactions, your loss from wash sales is realized.

And this will be shown on your consolidated 1099-B. that means it is as if the wash sales never happened.

your effective disallowed loss then results solely from any triggering transactions that you still had open on Jan 1 2021. You cant deduct those loses, since they are disallowed.

[Rick19744]

If you are trading actively, I believe you need to make sure you understand the tax consequences of your trades and be able to track your basis; especially if you are trading the same stock and "double especially" if you are trading within that 30 day window of the wash sale rules.

You need to also determine if you are an investor, active trader or active trader with a Section 475 election in place.  Because the later trader, known as trader tax status (with a 475 election), marks all open investments to market at the end of the year and all gains and losses are ordinary instead of capital gain / loss.

So at this point, since you just indicate that you are a trader, we have no idea which status you really fall into.  Plus, this is a facts and circumstances test so this determination is beyond the scope of this forum.

If the wash sale rules apply, any disallowed loss on the first transaction is rolled into the basis of your next purchase and only apply if there is a loss.  With you just providing the net gain or loss it is difficult to determine exactly how you are arriving at your figures.

Take a look at this high level discussion of the wash sale rules:

https://www.schwab.com/resource-center/insights/content/a-primer-on-wash-sales

[MuMiX]

I am eligible for Trader Status but I have not made the Mark-to-Market election.  I believe you have to make that election prior to the year in which you want it to apply.  So my gains would be treated as short-term capital gains instead of ordinary income.

I did not just provided my net gain or loss, I also provided the sum of my winning trades and the sum of the losing trades that would be disallowed in 2020 and realized in 2021.  The sum of the winning trades that I would be taxed on is 3.3 million, and the wash sale losses that would be deferred to 2021 is 3.2 million.  How did I come up with these numbers?  1099B and TurboTax.  Therefore I would pay taxes on 3.3 million despite only making 100k net profit.  The issue is that the disallowed loss from the first transaction would not simply roll into the "next" purchase, as I made many buys/sells throughout 2020 and into 2021, it would roll all the way into the most recent one until I stopped trading it.  So if I daytraded all year and into January 2021 on the same ticker, all those losses would roll into 2021.  I have read the IRS publications on the matter and it explicitly states that a loss cannot be rolled into a winning trade on the same day if you have a later purchase of the same ticker within 30 days.  You aren't allowed to use the net gain for the a single day -- you have to separate the wins and losses on that given day.  So if on a given day (such as last trading day in 2020), you day trade the same ticker with 100 round trips, and end up with $100k for the sum of the winning trades, and $95k for the losing trades... and you traded the same ticker in January 2021... you would pay taxes on the $100k and roll the $95k losses forward to 2021.

At this time, I think my only options are to hire a CPA/Tax laywer to ask for some kind of waiver/exception.  The tax bill is too high (I think) for applying for payments and also I would have too much money for applying for a financial hardship.  This is a complete mess!

I hope this message reaches other traders -- please be very careful about wash sale rules!!!

[jgr21]

What did you find out from your CPA? I'm in exactly the same boat, but my accountant says it doesn't work like that and that I show a 17k loss. I'm curious as to what you were told. Your scenario, just like mine, almost gave me a heart attack.

[Rick19744]

Be careful.  Not all tax preparer's understand the tax rules related to trader's / investor.

If you are actively trading with significant $$, then you need to find a tax professional that understands the rules.

You can be an active trader without the 475 election, but the wash sale rules do in fact impact you.  The only benefit you get with TTS without the 475 election is you are able to deduct expenses on Schedule C.

To be eligible for trader tax status (TTS) is a subjective test.  You can get some basic guidance from IRS Publication 550.  This is not an easy "test" to meet.

If you are not making a 475 election

• I recommend getting educated on this matter as the results can be disastrous. 
• Keep a "do not trade" list

Keep in mind that Section 1256 contracts are completely different.

This area is complex and beyond the scope of the forum.

[fanfare]

@jgr21 

MuMiX said:

"The sum of the winning trades that I would be taxed on is 3.3 million,"

Your winning trades have a cost basis ; the profit is 3.3 million minus whatever you paid for those shares.

For a day trader, your cost basis is going to be close to your proceeds.

Therefore, getting taxed on 3.3 million is just not going to happen.

[fanfare]

@MuMiX 

If you have a profit of $100K on the last trading day but a disallowed loss of $95k,

then when is the disallowed loss assigned?. You no longer have any shares.

Based on what you said, you will never deduct that loss.

[Rick19744]

@fanfare 

From my understanding of the limited facts, the reason for the $95k loss is the result of the wash sale rules.  So in fact, the OP does have the shares by reacquiring them.

The $95k loss gets realized by adjusting the basis of the "new" shares acquired during the 61 day wash sale period.

This is a big deal for those who day trade and don't keep track of stocks that are sold at a loss, then reacquired thinking the stock has bottomed out and will grow; AND this happens to straddle the end of the year.

Just too many unknowns to work through in order to provide much more assistance.

[MuMiX]

@Rick19744 - thanks for all the notes you provided. Certainly lots of details and everyone’s situation is different!

@jgr21 I only talked to one CPA and they did not think they could help me.  From my research I think there were only a few things of interest to my situation:

1. Check if your day trade buy and sell lots were matched up correctly (I use TD Ameritrade). On a typical day I make many round-trip trades, meaning I open a position and then completely close the position. You would think that regardless of a FIFO or LIFO tax lot method that when I completely close out a position that those shares would be matched with the corresponding opening trade, but they weren’t! It actually used my LIFO selection by taking the entire list of trades for the day and THEN matching them.  Turns out that my first buy of the day was being matched with the last sell of the day, even though I had completely closed out my position many times before then.  The effect of this is that instead of my normal small wins and small losses, I now have big wins and big losses (because the price moved from early in day to late in day so the buy/sell prices are now far from each other)…. and thus much higher tax bill and much higher wash sale.
2. A CPA can make a request to the IRS to allow you to use mark-to-market election even if you did not elect it in time. With luck maybe the IRS will agree…

My cost basis was way more than 3 mil but let me just paint the picture one more time with hypothetical example since some did not seem to understand.

Looking at only Winning trades- cost basis 1 mil, proceeds 2 mil. Net = 1 mil

Looking at only Losing trades- cost basis 1 mil, proceeds 0 mil. Net = -1 mil.

Now imagine all those losses are treated with wash-sale rule and you pay taxes on 1 mil even though your actual net profit was $0! That would be an infinite tax rate!!!

My original post was an exagerration. My actual scenario was that I actually made $100k but had to pay $200k because of wash sale rules (yay 200% tax!).  I’m rolling forward like $500k of capital gains losses indefinitely until I make that money back.  I used TaxAct software because it’s the only software I could find that allowed a number bigger than 10 mil (turbo tax and H&R Block don’t). I went ahead and paid the $200k because by paying it now instead of next year it will in effect be treating a lot of my income at a lower tax bracket (because I’ll likely make more in 2021 than 2020). I didn’t use the one CPA I talked to because he said his office has a policy against filing schedule C for traders and so I didn’t see the point in building a relationship with him. I am leaps and bounds above any requirements for trader status and do not plan to use mark-to-market election.

@fanfare, if I traded the last day of the year and sold the shares and did not buy those shares for 30 days then I would NOT have a loss from wash sale rule. All those losses would have been realized in the year they happened. But in my case, I continued trading the same stock into January and so my losses rolled forward into the January trades. So I will have a massive capital gain loss on the January trades that will carry forward indefinitely until i use up all those losses as deductions.

Quick soapbox- I could theoretically go lobby Washington to change the wash-sale rules as they apply to day traders, or I guess I’ll just have a trade a different stock one month of the year… or I’ll just take a vacation in December!  If all I have to do to work around it is take a vacation in December then it doesn’t really seem like the wash sale rule was implemented to address day trading… as I can still day trade with ease for 11 months of the year…

[Mr Washsale]

I feel your pain.   So looking at TD Ameritrade how do you know the wash sale damage around Dec if you keep the trade open or closed?  I want to  see what is being wash sale amount is disallowed?  This is the figure that makes turbo tax go up.

Thanks for the help

[Mike9241]

The question of how to determine how much you have in deferred losses due to wash sales might be best directed to TD which I believe is now part of Schwab.

perhaps you get a statement of your open positions showing tax basis at the end of any day you choose.   for long positions, you would need to know what you actually paid. the difference between the tax basis and what you paid would likely be the deferred wash sale amount on long positions. For short positions it would be the opposite, what you sold them for vs tax basis.

I realized this may be impractical if you have many open positions.  Perhaps Quicken or Quickbooks which would only be able to show you the taxable net gain or loss but not the deferred wash sale losses if importing/downloading of the transactions is possible. 

Wash sales on short sales can be complex, if you like read this thread 

https://fairmark.com/investment-taxation/capital-gain/wash/short-sales/ 

Perhaps you should consult a tax pro as to the advisability of making the M-T-M election if you qualify. 

[Mr Washsale]

Thanks I just ordered the book.  I tried calling TD but it has been difficult get answers or difffernet answers.  Not everyone has transferred to Schwab yet. Mid year 2024 for me. 

Once you carry over a wash sale by repurchasing the the same stock I am assuming you can only recapture those phantom tax by closing the trade wait 31 days and then have gains in the same stock? 

or does other gains offset the losses, maxe 3k a year?

any good books on correcting the error or making up for it ? 

I ws thinking of just closing the trades waiting 31 days and then have large divideneds to offset but it seams that these could be eventually long term and not the short term losses from the wash sale. 

any good books on correcting the error or making up for it (correcting to make whole)?  

Thanks.