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<<I need help understanding the correct way to report says of stock this year. Here is my situation:

(1) 7/5/96 ... bought 100 shares of Donna Karan (don't ask why). Total cost (with commission) was 2829.00.

(2) 7/14/97 ... DK is in the toilet ... bought 500 shares more. Total cost was 5456.88.

(3) 7/29/97 ... DK jumps up briefly. I wasn't Foolish at the time, so I get really excited. I sell 500 shares. Total proceeds (minus commission) was 6193.87.

So ... as I see it, there are three strategies here. I don't know which would be better, or which are even legal. So let me know what I am supposed to do here:

(a) Report the sale as being just the 500 shares I bought two weeks earlier. This makes a short-term gain of 736.99.

(b) The proceeds come to 1358.774 per hundred shares. Report the sale of my 100 shares long-term at a loss of 1470.23 (1358.77 - 2829) and the sale of 400 shares short-term at a gain of 1069.60 (5435.10 - 4365.50).

(c) Lump the short- and long-term shares together, getting an average cost basis of 1380.98 per hundred shares. Report the sale of my 100 shares long-term at a loss of 22.21 and the sale of 400 shares short-term at a loss of 88.82.

I should mention that I have other long-term gains to offset, totalling a little over 2100. I'm in the 28% tax bracket. What should I do? What CAN I do?>>

Sometimes I think I'd like to chuck the lawyer life and make a living somewhere teaching tax law. If I do, I may use this example as a test question.

Dow Danny gets half credit for his answer. He correctly points out that if you didn't specify which shares you were selling, you are deemed to have sold the shares you bought earliest, assuming you are dealing with a stockbroker and don't hold physical certificates. So you sold the original 100 shares for a long-term loss, and 400 of the newer shares for a short-term gain.

But there's another rule that comes into play: the wash sale rule. This rule disallows a loss on a sale of stock if you bought identical stock within the 61-day period beginning 30 days before the sale and ending 30 days after the sale. Your loss sale occurs less than 30 days after you bought identical shares (which you kept). So you are required to report short-term gain on the 400 newer shares, but you are not permitted to deduct the loss on the other 100 shares. If you are sufficiently philosophical you will note that this is better than having to report gain on all 500 shares.

To receive extra credit, a student would have to explain the further consequences of the wash sale. Your replacement shares now have a basis that is increased by the amount of the disallowed loss. If my arithmetic is correct, those shares had a cost basis of $1,091.38 (one-fifth of the 7/14/97 purchase). Add to that amount the disallowed loss of $1,470.23 (if that is the correct loss, see below) and you get a basis of about $2,562. The upshot of this is that your disallowed loss is "preserved" so that when you sell the replacement stock it will provide you with a loss (or a decreased amount of gain, if DK bounces back).

Your holding period on the replacement stock relates back to when you bought the original shares. You can't get a short-term loss by selling these shares. If you sell them for a gain, that gain will qualify for the 20%/10% rate for property held more than 18 months.

I should perhaps point out that your calculations are off, as you can easily see from the fact that your computed gain on 400 shares is greater than your gain on 500 shares. You have used $6,193.87 as your sale proceeds in one calculation and $6,793.87 in the other.

KAT in Chicagoland
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