Wash Sale Rule
The wash sale rule prohibits investors from claiming a tax loss on a security if they purchase a substantially identical security within 30 days before or after the sale, disallowing the loss for tax purposes but adding it to the cost basis of the new shares.
🎬 Video Explanation
Exam Tip
Wash sale = 30 days before OR after (61-day window total). Substantially identical triggers rule. Loss is DEFERRED to new basis. IRA wash sale = permanent loss!
What is the Wash Sale Rule?
The wash sale rule is an IRS regulation that prevents investors from claiming artificial tax losses by selling a security at a loss and quickly repurchasing it. If you buy a "substantially identical" security within 30 days before or after selling at a loss, the loss is disallowed for tax purposes.
The 61-Day Window
| Period | Rule |
|---|---|
| 30 days before | Cannot buy substantially identical |
| Sale date | Day loss is realized |
| 30 days after | Cannot buy substantially identical |
| Total window | 61 days |
What Triggers a Wash Sale
| Action | Wash Sale? |
|---|---|
| Buy same stock within 30 days | Yes |
| Buy call option on same stock | Yes |
| Spouse buys same stock | Yes |
| Buy in IRA, sell in taxable | Yes |
| Buy "substantially identical" ETF | Maybe |
| Buy similar but different stock | No |
| Buy same stock in different sector ETF | Generally no |
What Is "Substantially Identical"?
| Substantially Identical | NOT Substantially Identical |
|---|---|
| Same stock | Different company same industry |
| Options on same stock | Index fund vs. individual stocks |
| Convertible to same stock | S&P 500 ETF vs. Total Market ETF |
| Preferred that converts to common | Gold stock vs. gold ETF |
Consequences of Wash Sale
| Effect | Description |
|---|---|
| Loss Disallowed | Cannot deduct loss on current tax return |
| Basis Adjustment | Disallowed loss added to new shares' basis |
| Holding Period | Tacks on to new shares |
| Not Lost Forever | Loss deferred, not eliminated |
Example
| Step | Details |
|---|---|
| 1 | Buy 100 shares XYZ at $50 = $5,000 basis |
| 2 | Sell 100 shares XYZ at $30 = $3,000 |
| 3 | Loss = $2,000 |
| 4 | Buy 100 shares XYZ at $32 within 30 days |
| 5 | Wash sale triggered |
| 6 | $2,000 loss disallowed for current year |
| 7 | New basis = $32 + $20 = $52 per share |
How to Avoid Wash Sales
| Strategy | Implementation |
|---|---|
| Wait 31 days | Don't repurchase for 31 days |
| Buy different security | Similar but not substantially identical |
| Sell before buying | Don't buy 30 days before selling |
| Tax-loss harvest properly | Replace with similar, not identical |
Wash Sales Across Accounts
The wash sale rule applies across:
- All your taxable accounts
- Your spouse's accounts
- Your IRA (loss permanently disallowed!)
IRA Wash Sale Warning
| Scenario | Consequence |
|---|---|
| Sell in taxable account at loss | Loss potentially disallowed |
| Buy same stock in IRA within 30 days | Loss PERMANENTLY disallowed |
| Reason | Cannot adjust basis in IRA |
Exam Alert
Wash sale = 30 days before AND after sale (61-day window). Buying "substantially identical" security triggers rule. Loss is DEFERRED, not lost (added to new basis). Applies across ALL accounts including spouse's. IRA wash sale = loss permanently lost!
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Related Terms
Capital Gain
A capital gain is the profit realized when an investment or asset is sold for more than its original purchase price, subject to taxation based on holding period.
Tax-Loss Harvesting
Tax-loss harvesting is a strategy of selling investments at a loss to offset capital gains or ordinary income, thereby reducing tax liability while maintaining market exposure by purchasing similar (but not substantially identical) investments.
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