Returning Meme Stocks Carry Potential Hidden Tax Liabilities
In the world of stock trading, a 50-something investor made headlines in 2021 by raking in over $7 million in profits from meme stocks like AMC Entertainment, but also accumulated just over that amount in losses. This high-frequency trading strategy, facilitated by commission-free platforms like Robinhood, has become increasingly popular, but it comes with a potential pitfall: the wash sale rule.
The wash sale rule, a significant consideration for individual taxpayers who engage in frequent stock trading, especially with meme stocks and on commission-free platforms, prevents taxpayers from claiming a tax deduction on a loss if they buy the same or "substantially identical" stock within 30 days before or after selling it at a loss. This rule often applies to rapid buying and selling of volatile or popular meme stocks, as the losses from these sales are disallowed for immediate deduction and must be added to the cost basis of the repurchased stock, postponing the tax benefit until the final sale.
For users of commission-free platforms, the ease and low cost of rapid trading have encouraged high-frequency trading strategies. However, these platforms do not prevent wash sale violations. Traders may inadvertently trigger multiple wash sales if they sell losing positions and quickly buy the same securities or options again within the 61-day window (30 days before and after the sale). This makes record-keeping and understanding the wash sale rule particularly important for users of these apps.
It's essential to note that the wash sale rule applies not just across taxable accounts but also across all accounts controlled by the taxpayer and their spouse, including tax-deferred accounts like IRAs and 401(k)s. Selling in one account and buying in another does not avoid the rule.
The IRS has shown renewed interest in wash sales, partially due to the rise of meme stock trading and app-based platforms, indicating potential tighter scrutiny or enforcement. Investors should be cautious and track their transactions carefully to comply with the wash sale rule.
While the wash sale rule does not apply to crypto trading, the new Form 1099-DA requires reporting of disallowed wash sales on line 1i. Any disallowed loss due to a wash sale is added to the cost basis of the newly purchased stock, and the holding period of the stock that was sold is added to the holding period of the new stock, which may result in the sale being treated as a long-term gain.
As more individual taxpayers engage in commission-free stock trading, the younger generation relying on social media tips for investment advice, and the number of users of stock trading apps growing at a compound annual rate of 20% since 2016, it's crucial for investors to be aware of the wash sale rule and its implications. The IRS requires brokers to track and report wash sales that involve stocks, bonds, and most other common securities covered by the cost basis reporting rules.
In summary, frequent traders of meme stocks on commission-free platforms should carefully track transactions to comply with the wash sale rule, as it affects when losses can be claimed for tax purposes and complicates tax-loss harvesting strategies. The IRS may demand money from investors who have wash sales, even if they experienced significant losses.
- Investors using stock trading apps for meme stock trading, such as Robinhood, should be mindful of the wash sale rule, particularly when dealing with frequent stock trading, as this tax trap can prevent them from claiming a tax deduction on losses from selling and repurchasing the same or substantially identical stock within 30 days.
- Personal-finance enthusiasts engaging in commission-free stock trading, including crypto, need to remain vigilant about washing sales, as the IRS requirements state that any disallowed loss due to a wash sale is added to the cost basis of the newly purchased stock, potentially leading to a long-term gain and potential IRS scrutiny or enforcement, especially in the growing era of meme stock trading and app-based platforms.
