Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

What is the consequence of a wash sale to the investor's cost basis?

1. The loss is permanently disallowed

2. The disallowed loss is added to the new purchase's basis

3. No effect on cost basis

4. The cost basis is zero

The correct answer is: The disallowed loss is added to the new purchase's basis

The consequence of a wash sale to the investor's cost basis is that the disallowed loss is added to the new purchase's basis. This occurs because a wash sale happens when an investor sells a security at a loss and then repurchases the same or substantially identical security within a 30-day period before or after the sale. In this scenario, the IRS disallows the loss for tax purposes to prevent investors from claiming a tax deduction on a security that they still effectively own. However, to ensure that the investor is not permanently penalized by this disallowance, the adjusted cost basis of the newly purchased security incorporates the amount of the disallowed loss. This adjustment effectively postpones the tax consequences of that loss until the investor sells the new purchase in a non-wash sale scenario. This treatment is crucial for maintaining the integrity of capital gains and losses in the investor's overall tax situation. Understanding this principle is important for compliance with IRS regulations and effective tax planning strategies when managing investment portfolios.