this post was submitted on 07 Jul 2023
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I don't know the rules about wash sales but surely you could just buy S&P 500 index funds to truly diversify. Only thing to consider for ESPP is that you get taxed at the income tax rate (probably higher) if you sell ESPP funds you received within 12 months, and you get taxed as capital gains (probably lower) for anything held longer. So sell the longer-held stock first.
That's what I do. But if you sell at a loss within x days of acquiring more of the security, I think you lose tax benefits of the loss. But I am not sure if that is a significant worry or if it should prevent or delay when I choose to diversify into index funds.
Not a CPA, this is my understanding of the wash sale.
Let's say you buy your company's stock is currently trading at $100. You buy some shares at a discount, for $85, and hold them for a year, to leverage long term capital gains.
It is now December 2024, it turns out the stock has dropped in value and is now worth $80. You want to buy more to take advantage of the discount, and because you think it is likely underpriced. However you are worried that buying more will give you too much exposure to this single stock. A move you could do is sell the stock you owned, for $80, and buy back some stock, for $68 (since you get a discount). You could buy potentially the same amount you disposed of, ending up with the same value dollar-wise, but more stocks. Or maybe you have shares that are automatically bought through a pre-set plan.
Now this is when you trigger the wash sale. The wash sale rule doesn't say you can't do this, but it does say that if you do this, you cannot claim the loss on your taxes (in this case, the $5 loss arising from selling stock at $80 that you acquired for $85). What this means is that this loss will be added back to the cost basis of the new stocks you purchased for $68, giving you a cost basis of $73, and an unrealized gain of $7, as opposed to an unrealized gain of $12. So even though you can't claim the loss now, your realized profit later on will be $5 less, and you will eventually get the tax benefit. (I am looking at IRS publication 550, wash sale section).
Basically, you can buy and sell all you want (from the IRS' point of view. Your employer might have restrictions on holding periods and so forth), you just can't use that strategy to lower your tax bill artificially.
On a side note, diversifying away from your employer's stock can be good, because otherwise you double down on your risk. If your company is doing well, your portfolio increases, and your job is likely safe. If your company is not doing too well, you may lose your job at the same time as your portfolio taking a significant dip
Very helpful! Thanks for the post. If I understand correctly, the long term impact is negligible since the cost basis of newly acquired stock factors in this loss. So eventually when I sell the recent lots years down the road I'll be effectively getting a reduced gains tax (assuming there are gain). I just wasn't sure if wash sale considerations should impact how and when I choose to diversify my portfolio.