The wash sale rule is a regulation enforced by the Internal Revenue Service (IRS) that disallows investors from claiming a tax loss on the sale of a security if they purchase a "substantially identical" security within 30 days before or after the sale, creating a 61-day window. This rule applies to various investments, including stocks, bonds, mutual funds, exchange-traded funds (ETFs), and options, and it prevents investors from using capital losses to reduce their taxable income while maintaining their economic position in the market. If a wash sale occurs, the disallowed loss is not deducted in the current tax year but is instead added to the cost basis of the newly acquired security, effectively deferring the tax benefit until the replacement shares are sold. The rule also extends to transactions in tax-advantaged accounts like IRAs and applies to spouses' accounts, meaning that if one spouse sells a security at a loss and the other purchases a substantially identical security within the 61-day window, a wash sale is triggered.
Why does wash sale rule exist and how is tax loss harvesting anything special?
Understanding wash sales: What are they? What’s the penalty? Are there any tax implications? And how can you avoid them?
Can someone explain wash sales to me?
Wash Sale Rules
Videos
Say I have 100k to start the year. I buy two stocks. Stock A gains me $50k. I sell the stock and realize the gains. Stock B loses $10k and I sell the stock and realize the loss. I am up $40k net and will owe taxes on $40k. Where exactly is the tax loss harvest other than owing taxes on the sum of gains and losses? Where is the "tax loss harvest" benefit that we speak of?
In scenario 2, let's say I buy right back into stock B without waiting 31 days or whatever. Why does this have implications on anything? I did in fact lose and realize $10k on this stock and it isn't guaranteed I'll ever make it back.
sale and repurchase of a security
With tax season upon us, now’s the perfect time for a quick refresher on how wash sales work. And if you’ve still got questions, feel free to leave them in the comments below.
But first, let’s begin with a simple explanation of cost basis because the two go hand in hand:
What’s cost basis?
It’s the price you pay to purchase a stock or other investment, plus any other adjustments—like broker's fees or commissions.
OK, now on to wash sales:
What’s a wash sale?
A wash sale occurs when the same or a "substantially similar” investment is purchased within a 61-day window (30 days before or after the date you sold the loss-generating investment.) Wash sale rules apply to taxable accounts and IRAs owned by both the individual and a spouse, if applicable.
Which investments does a wash sale apply to?
These include stocks, bonds, options, mutual funds, ETFs, and reinvested dividends. (It’s considered a purchase when a dividend is issued and used to buy additional shares of a security).
What other transactions could trigger a wash sale?
Remember, you can’t get around a wash sale by selling an investment at a loss in a taxable account and then buying it back in a tax-advantaged account. In addition, the IRS has stated that it believes a stock sold by one spouse at a loss and purchased within the restricted time period by the other spouse is a wash sale. Fidelity will keep track of wash sales when they occur within the same account and by the same CUSIP, which is used to identify individual securities. If a wash sale crosses accounts or positions, then it will need to be accounted for by the taxpayer.
What’s the penalty for a wash sale?
If a wash sale does occur, you can't use the loss on the sale to offset gains or reduce taxable income. Instead, your loss will be added to the cost basis of the new investment. In addition, the holding period of the investment you sold is also added to the holding period of the new investment.
What are the tax implications of a wash sale?
In the long run, there may be an upside to a higher cost basis—you may be able to realize a bigger loss when you sell your new investment, or, if it goes up and you sell, you may owe less on the gain. If you do end up selling the new investment for a gain, the longer holding period may also help you qualify for the long-term capital gains tax rate rather than the higher short-term rate. If you end up selling the new investment for a loss, you may not have to wait as long for the wash sale window to pass. However, in the short term, you won't be able to use the loss to offset a realized gain or reduce your taxable income.
How can I avoid a wash sale?
One way to avoid a wash sale on an individual stock while still maintaining your exposure to the industry of the stock you sold at a loss, would be to consider substituting the stock with a mutual fund or an exchange-traded fund (ETF) that targets the same industry.
Some ETFs focus on a particular industry, sector, or other narrow group of stocks. These ETFs can be a good way to regain exposure to the industry or sector of a stock you sold, but they generally hold enough securities to pass the test of being not substantially similar to any individual stock.
Still got questions? Ask below or watch this 2-minute video explaining how wash sales work.