Pandemic Meme Stock Frenzy Digs Tax Pitfalls for Traders
Those who trade frequently may believe that they’re immune to capital gains tax if their losses offset their gains. However, they often overlook an important aspect called the ‘wash sale’ rule. This rule caught many off-guard during the frenzied trading of meme stocks spurred by the pandemic in 2021. Consider the case of an investor who took up day-trading during this time, particularly focusing on stocks like AMC Entertainment.
The investor experienced a financial rollercoaster, achieving over $7 million in gains but also incurring just slightly more in losses, which he assumed would create a tax-neutral situation. However, the reality was quite different due to the often-overlooked ‘wash sale’ rule. This regulation asserts that tax losses cannot be claimed on a stock sold at a loss, if you buy the same (or similar) security within a specific span, encompassing 30 days prior to or post the sale date.
The investor was stunned when the IRS marked over half a million dollars of his losses as ‘wash sales’. As a result, he was left with a weighty tax bill for the year 2021 that he’s still trying to settle, despite ending up with a net loss in his trading account for the year. This provided him with a harsh, yet timely, lesson about the perils of overlooking financial regulations, especially amidst the resurgence of meme stocks during the summer.
Take Opendoor Technologies as an example, a realty fintech company that saw its stock price soar to almost $40 per share during the meme stock surge in February 2021. Come June, the stock plummeted to a mere 51 cents, bringing it dangerously close to being delisted by NASDAQ. However, in a surprising twist, the stock price skyrocketed more than five times to reach $3.21 in July. As of yesterday, the closing price was $1.95.
A survey conducted by the World Economic Forum (WEF) studying investors worldwide uncovered some interesting statistics. It found that 57% of Gen Z and Millennials considered advice from online communities as imperative, compared to only 37% of Gen X, and a scant 20% of Baby Boomers. The report also estimated that since 2016, the user base of stock trading apps has been increasing at a compound annual growth rate of 20%.
If you’re among the new wave of these app-based traders, you should heed these warnings to avoid falling prey to the ‘wash sale’ tax trap. With basic knowledge of how Capital Gains Tax operates, you can save yourself from hefty tax bills. Most taxpayers have a foundational understanding that capital gains and losses come into play when a security is sold. Not all, however, are aware of the intricacies such as the ‘wash sale’ rule, which can result in unforeseen tax implications.