Join the NASDAQ Community today and get free, instant access to portfolios, stock ratings, real-time alerts, and more! Of course, many clients may wish to sell an asset to realize losses, then turn around and repurchase the same fund or security. However, there are techniques that can be employed for clients when trying to work around the wash sale rule.

A wash sale occurs when an investor sells an asset at a loss and, within 30 days, acquires "substantially identical" property. If a client trips over the wash sale rule, any loss is not currently deductible and actually raises the cost basis of the replacement property. Some clients may believe that a call option on a stock would not be substantially identical to holding the stock.

Indeed, call options are measured by delta to discern how similar to the stock they are. As an example, an at-the-money call is thought to have a delta of In other words, it is predicted that, for every dollar the stock moves, the option will move only 50 cents. This is certainly not identical, right? However, the government states that the sale of an equity and the purchase of a call option on that equity does actually trigger a wash sale.

Ironically selling a call for a loss and then buying the underlying stock does not.

Wash sale | Capital Gains and Wash Sale calculate Tax software for Schedule D - Neutral Trend TradeMax

If, within 30 days, she bought a call option on XYZ, she would flunk the wash sale test. This is true no matter what call option she buys. A partner at Deloitte suggested to us a three-step process to take a loss while not substantially disturbing alpha. This stock purchase has no wash sale penalty because, by purchasing the call, the wash sale rule has already been triggered and the penalty assessed adjusting upwards the cost basis in the call options.

Obviously, the order in which these trades are executed is very important; it might even be best not to buy the stock back until the next day, in order to avoid any possible confusion. This same penalty for call buying can also be handy for clients with unrealized losses in an index-related ETF.

Of course, the same strategy outlined above can be followed, but there is an even easier way to harvest the loss, with even less distortion to alpha. Exchange-traded index options are taxed differently than exchange-traded options on equities, and similarly to futures contracts on the same indices. Internal Revenue Code Section contracts are marked-to-market on December 31 of each year.

Unlike any other financial product, taxpayers are forced to recognize unrealized gains or losses without closing the position. When Section was put into place, Congressional tax writers concluded that this yearly taxation of futures and index options meant that all profits on these contracts would be taxed as short-term.

Is this a wash sale? In a put sale, the government will declare a wash sale when the put position is substantially identical to the stock — that is, when there is a high likelihood that the put will be exercised unlike the call purchase rule that damns any call purchase.

Most tax practitioners would have no issue if Mary sells an out-of-the-money put, a slight caution if Mary sells an at-the-money put and a genuine concern if the put is in-the-money, with concern growing as the put gets deeper and deeper in the money. This article was originally published at OnWallStreet.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc. Content originally published in On Wall Street. No further distribution, reuse, or republication permitted without the written consent of SourceMedia Inc.

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The wash sale rule is a nasty little piece of tax code - MarketWatch

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Wash Sale rule as it applies to selling puts | The Options Forum

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