Key Takeaways
- The wash sale rule under IRC Section 1091 disallows loss deductions when substantially identical securities are purchased within 30 days before or after the sale, creating a 61-day window.
- When a wash sale occurs, the disallowed loss is added to the basis of the replacement stock, and the original holding period tacks onto the new shares - but losses from IRA replacement purchases are permanently lost.
- IRC Section 267 defines related parties as family members (siblings, spouse, ancestors, lineal descendants) and entities more than 50% owned directly or indirectly by the same parties.
- Losses on sales between related parties under Section 267 are completely disallowed, but the buyer can use the disallowed loss to reduce gain on a subsequent sale to an unrelated party.
- Constructive ownership rules attribute stock ownership through family members, partnerships, and entities, but the "no double attribution" rule prevents family-to-family reattribution.
Wash Sales & Related Party Rules
Two important anti-abuse provisions in the Internal Revenue Code prevent taxpayers from claiming artificial tax losses: the wash sale rule under IRC Section 1091 and the related party rules under IRC Section 267. Both rules focus on situations where a taxpayer attempts to recognize a loss for tax purposes while maintaining substantially the same economic position.
Part 1: Wash Sale Rule (IRC Section 1091)
What Is a Wash Sale?
A wash sale occurs when you sell or trade stock or securities at a loss and, within 30 days before or after the sale, you:
- Purchase substantially identical stock or securities
- Acquire substantially identical stock or securities in a fully taxable trade
- Enter into a contract or option to acquire substantially identical stock or securities
The purpose of this rule is to prevent taxpayers from "harvesting" tax losses while immediately repurchasing the same investment.
The 61-Day Window
The wash sale period spans a total of 61 days:
| Period | Description |
|---|---|
| 30 days before | Purchasing replacement shares before the loss sale triggers wash sale |
| Day of sale | The actual sale date (Day 0) |
| 30 days after | Purchasing replacement shares after the loss sale triggers wash sale |
What Are "Substantially Identical" Securities?
Substantially identical includes:
- Shares of the same corporation's common stock
- Options, warrants, or rights to purchase stock of the same corporation
- Convertible bonds or preferred stock of the same corporation (if conversion is likely)
NOT substantially identical:
- Stock of different corporations (even in the same industry)
- Bonds vs. stock of the same corporation (unless convertible)
- Different mutual funds or ETFs tracking different indexes
Effect of Wash Sales on Basis and Holding Period
Basis Adjustment
When a wash sale disallows your loss, the disallowed loss is added to the basis of the replacement stock:
New Basis = Cost of Replacement Stock + Disallowed Loss
Example:
- You buy 100 shares of ABC Corp for $5,000 (basis: $50/share)
- You sell all shares for $3,500 (would-be loss: $1,500)
- Within 30 days, you buy 100 shares for $3,600
- The $1,500 loss is disallowed (wash sale)
- New basis = $3,600 + $1,500 = $5,100 ($51/share)
Holding Period Tack-On
The holding period of the original shares is added to the replacement shares' holding period.
The IRA Disaster: Permanently Lost Losses
CRITICAL EXCEPTION: If you sell stock at a loss in a taxable account and purchase replacement shares in an IRA, Roth IRA, or other tax-advantaged account within the 61-day window, the loss is permanently disallowed.
Under IRS Revenue Ruling 2008-5:
- The wash sale rule still applies (loss is disallowed)
- But you cannot increase the basis of the IRA shares because IRAs do not track basis for individual securities
- Therefore, the loss is forfeited entirely
Part 2: Related Party Rules (IRC Section 267)
Basic Rule: Loss Disallowance
Under IRC Section 267(a)(1), no deduction is allowed for losses on sales or exchanges of property between related parties.
Who Are Related Parties?
Family Members (267(c)(4)):
| Related | NOT Related |
|---|---|
| Brothers and sisters (whole or half-blood) | In-laws |
| Spouse | Stepchildren (unless legally adopted) |
| Ancestors (parents, grandparents) | Aunts and uncles |
| Lineal descendants (children, grandchildren) | Cousins |
Entity Relationships:
- An individual and a corporation in which they own more than 50% of the stock
- Two corporations that are members of the same controlled group
- A grantor and a fiduciary of the same trust
- An individual and their partnership (if ownership exceeds 50%)
Subsequent Sale Rule: Gain Reduction
If the related party buyer later sells the property at a gain to an unrelated party, the gain is recognized only to the extent it exceeds the previously disallowed loss.
Example:
- Father sells stock to Son for $50,000 (Father's basis: $80,000)
- Father has a $30,000 loss - disallowed under Section 267
- Son's basis in the stock is $50,000 (his cost)
- Son sells to an unrelated party for $90,000
- Son's realized gain = $90,000 - $50,000 = $40,000
- Son's recognized gain = $40,000 - $30,000 = $10,000
Comparison: Wash Sales vs. Related Party Rules
| Feature | Wash Sale (Section 1091) | Related Party (Section 267) |
|---|---|---|
| What triggers it | Repurchase of substantially identical securities within 61 days | Sale between defined related parties |
| Loss treatment | Deferred (added to new basis) | Disallowed (no carryforward for seller) |
| Basis adjustment | Yes - loss added to replacement stock basis | No - buyer's basis is their cost |
| Recovery of loss | Automatic upon future sale | Only if buyer sells at a gain |
EA Exam Tips
- Memorize the 61-day window: 30 days before + sale date + 30 days after
- Know the family members: Siblings, spouse, ancestors, and lineal descendants - NOT in-laws, aunts/uncles, or cousins
- Understand the IRA trap: Wash sale losses are permanently lost when replacement shares are in a tax-advantaged account
- More than 50%: Related party rules require MORE than 50% ownership - exactly 50% is NOT related
- Basis vs. recovery: Wash sales add loss to basis; related party losses are recovered through gain reduction by the buyer
Mark sells 100 shares of ABC Corp at a $2,000 loss on June 15. On June 30, he purchases 100 shares of ABC Corp for $4,500. What is his basis in the new shares?
Linda sells stock at a $5,000 loss in her taxable brokerage account. Twenty days later, her Roth IRA purchases the same stock. What happens to the $5,000 loss?
Which of the following is considered a "related party" under IRC Section 267?
Father sells rental property to his daughter for $200,000. Father's adjusted basis is $250,000. Daughter later sells the property to an unrelated buyer for $280,000. What gain does Daughter recognize?