Retiree Loses $2,400 to Wash-Sale Penalty on Tax-Loss Harvest

A 66-year-old retiree incurred an unexpected $2,400 tax penalty after violating the wash-sale rule while attempting to lower her tax bill through tax-loss harvesting. The story, reported by 24/7 Wall St., underscores a common pitfall for individual investors.

Details

The retiree, a widow living in Pennsylvania, relied on a $1.1 million brokerage portfolio to generate approximately $55,000 in annual income to supplement her Social Security benefits. She followed a standard strategy of selling losing stocks to offset capital gains, known as tax-loss harvesting.

However, she made a common mistake: she repurchased the same stocks (including Johnson & Johnson JNJ, Procter & Gamble PG, and Coca-Cola KO) within 30 days of selling them. This triggered the IRS wash-sale rule, which disallows the loss deduction.

Context

The wash-sale rule prevents investors from claiming a capital loss if they repurchase the same or substantially identical security within 30 days before or after the sale. The rule aims to prevent artificial losses for tax purposes.

In this case, the retiree was unaware of the rule, resulting in $2,400 in penalties and interest. The story serves as a reminder of the importance of understanding tax rules before implementing loss-harvesting strategies.

What This Means for Investors

Investors, especially retirees relying on their portfolios, should exercise caution when selling stocks at a loss. Consulting a tax or financial advisor before executing tax-loss harvesting strategies is advisable, and waiting at least 31 days before repurchasing the same stock ensures compliance with IRS rules.