Wash Sales 101

The wash sale rule postpones losses if you buy replacement shares around the same time.

When the value of an investment goes down you get that sinking feeling — you’ve lost money. But the tax law doesn’t allow that loss until you sell the investment. In a way that’s good, because it means you can control the timing of your deduction, taking it when the benefit is the greatest.

The problem is, you may have a conflict. You want to deduct the loss, but also want to keep the investment because you think it’s going to bounce back. It’s tempting to think you can sell it and claim the loss, then buy it back right away. And that’s where the wash sale rule comes in. If you replace the investment shortly after the sale — or shortlybeforethe sale — this rule can prevent you from deducting your loss.

General Rule

In general you have a wash sale if you sell a specified asset at a loss, and buy substantially identical securities within 30 days before or after the sale.

Contracts and Options

The wash sale rule can apply even if you don’t replace the investment. If you enter into a contract or option to acquire a replacement, that’s enough to make the wash sale rule apply. Your sale can also be a wash sale if, within the wash sale period, you sell a put option that’s “deep in the money.” See Wash Sales and Options.

Consequences of a Wash Sale

The wash sale rule actually has three consequences:

You are not allowed to claim the loss on your sale.
If you acquired a replacement for the investment, your disallowed loss is added to its basis.
Your holding period for the replacement includes the holding period of the stock you sold.

The first one is clear enough, but the others may require some explanation.

Basis Adjustment

The basis adjustment is important: it preserves the benefit of the disallowed loss. You’ll receive that benefit on a future sale of the replacement.

Example:Some time ago you bought 80 shares of XYZ at $50. The stock has declined to $30, and you sell it to take the loss deduction. But then you see some good news on XYZ and buy it back for $32, less than 31 days after the sale.

You can’t deduct your loss of $20 per share. But you add $20 per share to the basis of your replacement shares. Those shares have a basis of $52 per share: the $32 you paid, plus the $20 wash sale adjustment. In other words, you’re treated as if you bought the shares for $52. If you end up selling them for $55, you’ll only report $3 per share of gain. And if you sell them for $32 (the same price you paid to buy them), you’ll report a loss of $20 per share.

Because of this basis adjustment, a wash sale usually isn’t a disaster. In most cases, it simply means you’ll get the same tax benefit at a later time. If you receive the benefit later in the same year, the wash sale may have no effect at all on your taxes.

There are times, though, when the wash sale rule can have truly painful consequences.

If you don’t sell the replacement in the same year, your loss will be postponed, possibly to a year when the deduction is of far less value.
If you die before selling the replacement, neither you nor your heirs will benefit from the basis adjustment.
You can also lose the benefit of the deduction permanently if you sell stock and arrange to have a related person or entity, such as your IRA, replace the investment.
As explained in my book,Consider Your Options, a wash sale involving shares of stock acquired through an incentive stock option can be a planning disaster.

Holding Period

When you make a wash sale, your holding period for the replacement includes the period you held the investment you sold. This rule prevents you from converting a long-term loss into a short-term loss.

Example:You’ve held shares of XYZ for years and it’s been a dog. You sell it at a loss but then buy it back within the wash sale period. When you sell the replacement stock, your gain or loss will be long-term — no matter how soon you sell it.

In many situations you get more tax savings from a short-term loss than a long-term loss, so this rule generally works against you.

Additional Rules

There’s a lot more to the wash sale rule. We’ve had questions about all of the following issues:

You don’t have a wash sale unless the asset you acquire (or enter into a contract or option to acquire) issubstantially identical.
You don’t have a wash sale, even though you bought an identical investment within the previous 30 days, if it wasn’t areplacement investment.
There are mechanical rules to handle the situation where you don’t buy exactly the same quantity of the investment as you sold, or where you bought and sold multiple lots. SeeWash Sale Matching Rules.
Your loss may be disallowed if a person who’s related to you — or an entity related to you, such as your IRA — buys replacement property.
You don’t actually have to purchase stock within the wash sale period to have a wash sale. It’s enough if you merely enter into acontract or option to acquire replacement stock.
Short salespresent a special problem in connection with the wash sale rule.
There are special considerations inapplying the wash sale rule to traders.

Losses Only

The wash sale rule only applies to losses. You can’t wipe out a gain from a sale by buying the same stock back within 30 days.

Planning for Wash Sales

What can you safely do to plan around the wash sale rule? No technique is completely safe. Here are some ideas to consider.

Most obviously, you can sell the stock and wait 31 days before buying it again. (Check your calendar carefully!) The risk here is that the stock may rise in price before you can repurchase it.
If you’re truly convinced the stock is at rock bottom, you might consider buying the replacement stock 31 days before the sale. If the stock happens to go up during that period your gain is doubled, and if it stays even you can sell the older stock and claim your loss deduction. But if you’re wrong about the stock, a further decline in value could be painful.
If your stock has a strong tendency to move in tandem with some other stock, you may be able to reduce your risk of missing a big gain by purchasing stock in a different company as “replacement” stock. This is not a wash sale because the stocks are not substantially identical. Thirty-one days later you can switch back to your original stock if that is your wish. But there’s no guarantee that any two stocks will move in the same direction, or with the same magnitude.

There’s no risk-free way to get around the wash sale rule. But then again, continuing to hold a stock that has lost value isn’t risk-free, either. In the end it’s up to you to evaluate all the risks, and balance them against the benefit you’ll receive if you can claim a deduction for your loss.

Wash Sales 101 - (2024)

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