What Constitutes a Wash Sale
Stocks or securities of one company are generally not considered substantially identical by the IRS to those of another. As well, the bonds and preferred stock of a company are also ordinarily not considered substantially identical to the company’s common stock. However, there are circumstances in which preferred stock, for example, could be considered substantially identical to the common stock. This would be the case if the preferred stock is convertible into common stock without any restriction, has the same voting rights as the common stock, and trades at a price close to the conversion ratio.
If the loss is disallowed by the IRS because of the wash-sale rule, the taxpayer has to add the loss to the cost of the new stock, which becomes the cost basis for the new stock.
For example, consider the case of an investor who purchased 100 shares of Microsoft for $33, sold the shares at $30, and within 30 days bought 100 shares at $32. In this case, while the loss of $300 would be disallowed by the IRS because of the wash-sale rule, it can be added to the $3,200 cost of the new purchase. The new cost basis, therefore, becomes $3,500 for the 100 shares that were purchased the second time, or $35 per share.