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Duration: 8:43

Instructor:

Contributor: Interactive Brokers

Level: Beginner

The main topics of this lesson are: Wash Sales; Section 1256; Commodities; and Foreign Currency Transactions. For this lesson refer to the Study Notes and watch the video for a synopsis.

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Study Notes:

Wash sales

What is a wash sale?

A wash sale occurs when you sell a security (stock, bond, option), and, within 30 days before OR after
the sale, you buy a substantially identical security, including a contract or option to buy a substantially
identical security. The wash sale prohibits the loss from being claimed as a tax and results in the
disallowed loss being added to the basis of the newly acquired holding.

The word substantially is repeated because the rule was initially aimed at stopping both trading for
losses and swinging from one security to another in the same industry in order to “harvest” losses to
lower or eliminate taxes. The IRS (and the courts) has interpreted “substantially identical” to be a
holding in the same company. However, it can be a different type of holding (option vs. shares,
preferred stock vs. common stock). Keep in mind that when a wash sale occurs the loss is just
postponed; it is not lost for tax purposes. The loss adds to the basis of the security purchased and any
gain is subsequently reduced by the loss or an additional loss is increased.

Section 1256

Section 1256 allows for special capital gain treatment for the trading of index options. Section 1256
does not apply to single stock options. Section 1256 treats any gains or losses on an index option as
40% short-term gain/loss and 60% long-term gain/loss no matter what the holding period is. This is
advantageous if there are gains because a greater percentage of the gain is taxed at a lower rate. There
is one catch. All Section 1256 contracts are “closed” at the end of a year and all gains and losses are
recognized for tax even though they may not have been realized. Each contract is, for tax purposes,
marked to market at year end and treated as if it was sold and repurchased at the same price.

Commodities

Commodities are traded as contracts for future delivery of an item. If the purchase occurs within the
ordinary course of business – meaning it is purchased for use – any gains/losses are treated as ordinary
income. If they are purchased as an investment, the typical gain/ loss rules apply.

Foreign Currency Transactions

Investors encounter foreign currency transactions in two different ways. First, a transaction in a
security where payment and sale is made in a foreign currency. In that case, any gain or loss in the
change in value of the currency is included with the gain or loss of the security and treated as a
gain/loss subject to the holding period rules, just as if the transaction had occurred in the base
currency (your normal currency).

Second, investors may invest in the currency itself and hold the currency in an account. No
income (other than interest if the account is interest bearing) is recognized on currency held for
investment.

Once the currency is converted back to the base currency then any resulting gain/loss is treated as
ordinary income. Remember that the currency must go back to the base currency for income/loss
recognition. For example: if you have a base currency of USD and buy GBP and then trade GBP to
Euro no gain or loss would be recognized. Once the Euros were converted back to USD any gain or
loss would be recognized. No holding period rules apply as currency gains/loss are always treated as
ordinary income.

Disclosure: Interactive Brokers

The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

Supporting documentation for any claims and statistical information will be provided upon request.

Any stock, options or futures symbols displayed are for illustrative purposes only and are not intended to portray recommendations.

Disclosure: Tax-Related Circular 230 Notice

The information in this presentation is provided for informational purposes only, and does not constitute tax advice and cannot be used by the recipient or any other taxpayer to avoid penalties under any federal, state, local or other tax statutes or regulations, or to resolve any tax issue.

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