The wash sale rule is an IRS-enforced rule stating that, in order to realize a taxable loss, an investor cannot sell an investment for a loss and repurchase the same investment for 30 days. Investors must wait 31 days to re-buy the security.
What Is A Wash Sale In Stocks?
Investors seek to offset capital gains taxes with losses over the same period of time. As such, they might sell a losing stock at the end of the year. If the losses from selling the stock are used to offset gains, or to claim a capital loss for the tax year, the investor may not repurchase that same stock within 30 days. Doing so is called a wash sale and is prohibited by the IRS.
The wash sale involves selling a stock for a loss and then buying back the same security within 30 days of selling. If an investor waits until the 31st day to repurchase the stock, it is not considered a wash sale.
How a Wash Sale Works
The mechanics of the wash sale are simple. If an investor purchased XYZ stock with a $100 per share cost basis, but it is now trading at $75 per share, there is an unrealized loss. The investor might have another stock that he sold for a $25 per share capital gain. If he sells XYZ stock and takes the loss, he can offset the capital gain tax on the profitable sale.
But let's say that the investor still really likes the fundamentals of XYZ stock and wants to continue to hold it in his portfolio. While he is entitled to rebuy the stock at any time, if he repurchases it within 30 days of selling it for the capital loss, he has conducted a wash sale and can't claim the capital loss.
What Does 'Wash Sale Loss Disallowed' Mean?
An investor might get a notification stating that a "wash sale loss disallowed," which simply means that the transaction has been marked as a wash sale, and the investor won't be able to claim the losses on his tax return. It's important to note that an investor may get this notification even if it isn't the exact same security.
The IRS rule states that "substantially identical securities" are disallowed. This means that the investor might buy a different security that is deemed an equivalent security in type, making the sale and purchase a wash sale.
Investments Subject To The Wash Sale Rule
Investors should know that the wash sale rule applies to sales and purchases of:
- Mutual funds
When the tax loss rule considers a substantially identical security, it is generally referring to a new or old security from the same corporation that may have gone under some reorganization.
What Isn't Subject To The Wash Sale Rule?
The wash sale rule refers to selling securities for a loss. If you sell a security for a gain, you can repurchase the security within 30 days without violating the tax loss rule because you'll be reporting gains on the security.
Tip: The wash sale rule does not apply to cryptocurrency sales at the moment as the IRS classifies crypto as property and not a security.
How To Calculate A Wash Sale Adjustment
When there is a wash sale, the loss is deferred until a later date when the investment is sold and the gain or loss can be realized. The amount of the loss is added to the cost basis to create a new cost basis for the security.
Wash Sale Deferred Loss Example
Let's take a look at an example on how the deferred loss works. An investor bought 100 shares of ABC stock for $54 per share. They then sold the shares for $50 per share. The investor then repurchased 100 shares of ABC stock for $52 per share. The $400 loss is disallowed by the IRS - it cannot offset any capital gain. But because of the wash sale rule, the $400 can be added to the new cost basis of $5,200. The new cost basis is $5,600 or $56 per share.
How To Avoid A Wash Sale Loss
Because the IRS views the wash sale as equal securities, you can avoid a wash sale loss by taking the money generated from the sale and investing that into a mutual fund or ETF that is in the same industry. The IRS doesn't view that as a wash sale and it is permitted.
For example, if you sold an oil and gas stock from your portfolio, you can avoid the wash sale by purchasing an oil and gas mutual fund or a fund that has a major holding of oil and gas stocks - even if it includes the one that you sold.
Note: Buying another security in the same industry is not considered a wash sale and is allowed. Investors can either do that or wait 30 days to repurchase the same security.
In order to fully realize any losses on a sale of a security intended to be repurchased, investors need to avoid a wash sale and wait until the 31st day to repurchase the security. Failure to do so means that the capital loss cannot be realized on the investor's tax return.
A wash trade is one where the investor doesn’t change his portfolio scope because he sells a security and then buys it or something that is the equivalent back. Wash trades are disallowed by the IRS when it comes to taking a capital loss on securities.
Investors must wait at least 30 calendar days to repurchase a security in their portfolio to avoid a wash sale loss.
Investors must pay taxes on gains from the sale of securities. Wash sales usually result in a loss that adds to the cost basis of the security that is later used when liquidating the stock for a gain. It may help offset future gains.
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