Of all the accounting tasks required for active traders to file their taxes, calculating wash sales has to be the most daunting. When trading the same stocks over and over again, buying and selling unequal share amounts, making small gains and losses, hundreds or thousands of wash sales are inevitably generated.

Therefore, this rule is unbelievably cumbersome when it comes to filling out a proper schedule d. How can a rule that sounds relatively simple cause so much confusion and headaches? Read on...

What exactly is the wash sale rule? IRS publication 550 page 52 states:

You cannot deduct losses from sales or trades of stock or securities in a wash sale. A wash sale occurs when you sell or trade a stock or securities at a loss, and within 30 days before or after the sale you: buy substantially identical stock or securities, acquire substantially identical stock or securities in a fully taxable trade, or acquire a contract or option to buy substantially identical stock or securities."

"If you sell stock and your spouse or a corporation you control buys substantially identical stock, you also have a wash sale."

The IRS further states that "If your loss was disallowed because of the wash sale rules, add the disallowed loss to the cost of the new stock or securities. The result is your basis in the new stock or securities. This adjustment postpones the loss deduction until the disposition of the new stock or securities. Your holding period for the new stock or securities begins on the same day as the holding period of the stock on securities sold."

In plain English, this means that if you close a trade and take a loss, and then buy back the same, or "substantially" the same equity, you cannot take the loss at that time.

According to the IRS, the loss now has to move forward, and has to be attached to the cost basis of the trade in which you bought back the same stock. If that trade also ends in a loss due to the new cost basis, and you buy the same stock again, the loss gets moved forward again.

This can keep happening indefinitely if you continue to trade the same equity again and again and keep ending up with a loss, and do not stop trading for at least 31 days.

In addition, the holding period of your trade may also change, thus changing the wash sales tax. I am sure you can see how calculating and keeping track of the many nuances of this rule is an active traders worst nightmare and potentially could end up costing you money come tax time.

Heres just a brief look at some of the other problems associated with wash sale accounting. Well consider each of these topics in-depth as our series continues.

Wash Sales on Unequal Numbers of Shares - When you buy back shares of stock in increments that do not equal the number of shares sold at a loss, it is the traders responsibility to determine the particular shares to which the wash sale rule applies. This requires complex matching and splitting of shares based on the order in which the shares were purchased and sold.

Wash Sales on Short Sales - If you short sell stock, this adds a whole new dimension to the wash sale rule since you must also now be concerned with sales rather than purchases that trigger wash sales. When you buy-to-cover a short sale and take a loss, if you short that stock again within 30 days, you will trigger a wash sale.

Wash Sales between Stocks and Options - If you take a loss on a stock or an option then buy an option on the same stock within the 30 day window, you will also have triggered a wash sale.

You would think that the IRS would only care to see wash sales that cause losses to be deferred to another tax year, but this is not the case. The IRS requires that traders report each and every wash sale throughout the year. This means that each time a stock that is sold at a loss is repurchased within the +/- 30 day window, a wash sale must be reported on the schedule d.

Therefore, an active trader may have hundreds or even thousands of wash sales throughout the year. Even the casual investor may be plagued by having to report several or many wash sale occurrences. What every trader needs then, is an automated method to deal with this headache. Thankfully such software does exist.