What Is a Substantially Identical Security?

A "substantially identical security" is a term defined by the U.S. Internal Revenue Service (IRS) in the context of the wash sale. rule. It refers to securities that are no🔯t considered different enough to be treated as separate investments. The IRS treats these securities as tooꦦ similar for tax-loss harvesting or tax swaps.

This can include both new and old securities issued by a corporation that has undergone a reorganization, convertible securities, or common stock from the same corporation. Essentially, if the market price and conversion prices are the same, these securities cannot be used in tax strategies like tax-loss harvesting.

Understanding a Substantially Identical Sꦗecurity

Tax swaps, or tax-loss harvesting strategies, allow an investor to sell a stock or exchange-traded fund (ETF) that has gone down in price and thus incur a 澳洲幸运5官方开奖结果体彩网:capital loss. This helps investors reduce taxes from capital gains earned elsewhere. Tax-loss harvesting has become increasingly popular as algorithmic trading and investment management services such as 澳洲幸运5官方开奖结果体彩网:robo-advisors are able to tax-loss harvest on your behal🌺f aut🐠omatically.

However, to preserve their overall portfolio strategy, some investors will immediately purchase a very similar security to the one that was sold for a tax loss, hoping that it will return to, and perhaps exceed, its former value. For example, if an investor sells the 澳洲幸运5官方开奖结果体彩网:SPDR S&P 500 ETF (SPY) at a loss, they may immediately turn around and purchase the Vanguard S&P 500 ETF (VOO).

The rationale is that the two S&P 500 ETFs have different 澳洲幸运5官方开奖结果体彩网:fund managers and different 澳洲幸运5官方开奖结果体彩网:expense ratios, may replicate the underlying index using a different methodology, and may have different levels of liquidity in the market. Presently, the IRS does not deem this type of transaction as involving substantially identical securities, and so it is allowed, although this may be subject ♐to change in the future as the practice becomes more widespread.

In another example, if a trader sells Berkshire Hathaway Class A shares at a loss in order to buy Berkshire Hathaway Class B shares, that may be 澳洲幸运5官方开奖结果体彩网:considered a wash sale involving substantially identical securities because the two securities market the same portfolio at different price points. However, if they sold the Berkshire Class A shares in order to buy shares of a closely related stock issued by another company, the wash sale rules would not apply.

Wash Sales

If the IRS deems Berkshire Class A and Berkshire Class B shares to be substantially identical securities, the tax benefits gained from the strategy would not be allowed by the IRS, and would instead be considered a wash sale. In the United States, wash sale laws are codified in the Internal Revenue Code and Treasury regulations. Capital gains and losses, including those related to wash sales, are reported using 澳洲幸运5官方开奖结果体彩网:IRS Schedule D (澳洲幸运5官方开奖结果体彩网:Form 1040).

Under Section 1091 of the Treasury regulations, a wash sale occurs when an investor sells stock (or other securities) at a loss, and♌ within 30 days before or after the sale:

• Buys substantially identical stock or securities
• Acquires substantially identical stock or securities in a fully taxable trade
• Enters into a contract or option to buy substantially identical stock or securities
• Acquires substantially identical stock for an 澳洲幸运5官方开奖结果体彩网:individual retirement accoun♛t (IRA) or Roth IRA

The Bottom Line

Securities that are not considered different enough to be treated as separate investment are treated as substantially identical securities. The IRS enforces its wash sale rules, so it's important to understand the impact of buying and selling substantially identical securities within a short time frame. If you want to maximize your 澳洲幸运5官方开奖结果体彩网:tax-loss harvesting strate꧟gies, pay close attention to 🔯the sale date and subsequent purchase date of any securities that could be substantially similar to each other. These rules apply to purchases within 30 days before or after a sale.