Wash Sale: Definition, How It Works, and Purpose (2024)

What Is a Wash Sale?

A wash sale is a transaction in which an investor sells or trades a security at a loss and purchases "a substantially similar one" 30 days before or 30 days after the sale. This is a rule enacted by the Internal Revenue Service (IRS) to prevent investors from using capital losses to their advantage at tax time.

The wash sale rule applies to stocks, contracts, options, and all other types of securities and trading.

Key Takeaways

  • A wash sale occurs when an investor purchases a security 30 days before or 30 days after selling an identical or similar security.
  • The IRS instituted the wash sale rule to prevent taxpayers from using the practice to reduce their tax liability.
  • Investors who sell a security at a loss cannot claim it if they have purchased the same or a similar security within 30 days (before or after) the sale.

Understanding a Wash Sale

Many countries' tax laws allow investors to claim a specific amount of capital losses on their taxes as an income reduction. In the U.S., you can claim up to $3,000 or your total net loss, whichever is less. If you have more than $3,000 in capital losses, you can carry the additional loss forward into the following years.

The ability to carryover losses led to investors inventing a loophole where they would plan to sell a losing security and buy it again within a short period. This allowed them to claim a capital loss and use that loss to mitigate tax liabilities.

To prevent the abuse of this incentive, the Internal Revenue Service (IRS) instituted the Wash Sale Rule in the U.S. (In the U.K., the practice is known as bed-and-breakfasting, and the tax rules in the U.K. have an implementation similar to the Wash Sale Rule). The law states that if an investor buys a security within 30 days before or after selling it, any losses made from that sale cannot be counted against reported income. This effectively removes the incentive to do a short-term wash sale.

How It Works

Generally, a wash sale has three parts.

  1. An investor notices they are in a losing position, so they close it by selling the stock or exiting a trading position.
  2. The sale allows them to take a loss that they can legally claim on their tax returns as a reduction of their earnings for that year, which reduces their total tax liability.
  3. The investor will look to purchase the security at or below the price at which they sold it—if the purchase occurred 30 days before or after the sale, it is considered a wash sale, and the loss cannot be claimed.

Day traders, especially pattern day traders—those that execute more than four day trades over a five-day period in a margin account—may encounter wash sales regularly. The wash sale rule still applies to these traders. The tax implications for day traders are complex, so it's best to consult a tax professional if you're day trading.

Wash Sale Example

Assume an investor has a $15,000 capital gain from the sale of ABC stock. They fall in the highest tax bracket and must pay a 20% capital gains tax of $3,000. But let’s say they sold XYZ security for a loss of $7,000. The net capital gain for tax purposes would be $15,000 - $7,000 = $8,000, which means they’ll have to pay only $1,600 in capital gains tax. Notice how the realized loss on XYZ reduces the gain on ABC, reducing the investor’s tax bill.

However, if the investor repurchases XYZ stock—or a stock substantially identical to XYZ—within 30 days of the sale, the above transaction is counted as a wash sale, and the loss is not allowed to offset any gains.

Special Considerations

The IRS does not ordinarily consider bonds and preferred stock of an issuing company to be substantially identical to the company’s common stock. However, there may be circ*mstances where preferred stock, for example, may be considered substantially identical to the common stock.

This would be the case if the preferred stock is convertible into common stock without any restriction, has the same voting rights as the common stock, and trades at a price close to the conversion ratio.

Per Revenue Ruling 2008-5, IRA transactions can also trigger the wash-sale rule. If shares are sold in a non-retirement account, and substantially identical shares are purchased in an IRA within 30 days, the investor cannot claim tax losses for the sale, nor is the basis in the individual's IRA increased.

Reporting a Wash Sale Loss

The good news is that any loss realized on a wash sale is not entirely lost. Instead, the loss can be applied to the cost basis of the most recently purchased substantially identical security. Not only does this addition increase the cost basis of the purchased securities, but it also reduces the size of any future taxable gains as a result.

Thus, the investor still receives credit for those losses, but at a later time. Also, the holding period of the wash sale securities is added to the holding period of the repurchased securities, which increases an investor’s odds of qualifying for the 15% favorable tax rate on long-term capital gains.

Tax-Lost Harvesting and Wash Sales

Tax-loss harvesting can inadvertently lead to wash sales if not carefully managed. Tax-loss harvesting is the strategy of selling securities at a loss to offset a capital gains tax liability elsewhere and then buying back a replacement security to maintain the existing portfolio's overall composition. The objective is to lower your overall tax bill by realizing those losses. However, if you're not careful about how you replace the securities you've sold, you can trigger the wash sale rule. To avoid this, investors often look for alternative investments that are similar but not substantially identical.

Are Wash Sales Illegal?

A wash sale is not illegal—there is no wording that states you cannot sell a security and purchase a substantially similar one 30 days before or after the sale. The rule only makes it so you can't claim a loss on the sale in that year's tax filing.

Is a Wash Sale Window 30 or 60 Days?

A wash sale is a total of a 60-day window—starting from 30 days before the sale to 30 days after the sale.

How Do I Avoid a Wash Sale?

If you have sold or intend to sell a security at a loss, you can avoid triggering the wash sale rule by purchasing a similar instrument 31 days or more before or after the sale.

The Bottom Line

A wash sale occurs when an investor sells a security at a loss and then purchases the same or a substantially similar security within 30 days, before or after the transaction. This rule is designed to prevent investors from claiming capital losses as tax deductions if they re-enter a similar position too quickly. While not illegal, wash sales have negative tax implications: losses from such sales cannot be used to offset gains in the same tax year. However, these losses can be added to the cost basis of the newly purchased security, affecting future gains. This rule is relevant to all types of securities and trading, and it's particularly significant for day traders and investors looking to use capital losses to mitigate tax liabilities. Understanding and navigating the wash sale rule is crucial for effective tax planning and investment strategy.

Correction—Oct. 14, 2022: A previous version of this article misleadingly stated that a wash sale occurred when selling a security at a loss for a tax benefit. It also incorrectly stated that an investor could not purchase the same or similar security within the 60-day window of 30 days before or 30 days after selling it.

Wash Sale: Definition, How It Works, and Purpose (2024)


How does the wash sale rule work? ›

Q: How does the wash sale rule work? If you sell a security at a loss and buy the same or a substantially identical security within 30 calendar days before or after the sale, you won't be able to take a loss for that security on your current-year tax return.

How do you count 30 days for a wash sale? ›

A Wash Sale occurs if you sell securities at a loss and buy substantially identical replacement shares within 30 days before or after the sale. The Wash Sale Period is 30 days before and 30 days after the sale date, totaling 61 days (including the sale date).

Is the wash sale rule 30 or 60 days? ›

Is a Wash Sale Window 30 or 60 Days? A wash sale is a total of a 60-day window—starting from 30 days before the sale to 30 days after the sale.

What is the concept of wash sale? ›

A Wash Sale is when an individual sells a security at a loss and within 30 days before or after such sale, repurchases a 'substantially identical' stock or security. Thus, the total period for a Wash Sale is 61 days which includes 30 days before the sale, the date of the sale and 30 days after the sale.

What is an example of a wash sale? ›

For example, let's say you have 100 shares of XYZ stock that you bought for $10 a share, or $1,000 total. You sell the stock for $8 a share and then 23 days later re-buy 100 shares for $7 a share. Because you've repurchased the stock within the 30-day window, you have a wash sale.

How does the IRS know about wash sales? ›

Note: Wash sales are in scope only if reported on Form 1099-B or on a brokerage or mutual fund statement. Click here for an explanation. A wash sale is the sale of securities at a loss and the acquisition of same (substantially identical) securities within 30 days of sale date (before or after).

Can I buy back into the same stock after 30 days to avoid a wash sale? ›

Keep in mind that the wash sale rule goes into effect 30 days before and after the sale, so you have a 61-day window to avoid buying the same stock. Alternatively, if waiting 61 days isn't feasible, you can purchase a security that is not substantially identical to the one you recently sold.

Why are capital losses limited to $3,000? ›

The $3,000 loss limit is the amount that can be offset against ordinary income. Above $3,000 is where things can get complicated.

Can a wash sale be reversed? ›

You can either buy something else that is not substantially identical or wait beyond the 30-day window to repurchase the shares. (You still have a wash-sale on the original sale and repurchase. You realize the loss on the subsequent sale.)

What is an example of a wash trade? ›

Here's a simple wash trade example: Say an investor who's actively involved in day trading owns 100 shares of ABC stock and sells those shares at a $5,000 loss on September 1. On September 5, they purchase 100 shares of the same stock, then resell them for a $10,000 gain.

How to report wash sales? ›

If you have a loss from a wash sale, you cannot deduct it on your return. Additionally, a gain on a wash sale is taxable. Forms 8949 and Schedule D will be generated automatically based on the entries. When you report the sale of the newly purchased stock, you will adjust the basis to account for the loss.

How to recover wash sale loss disallowed? ›

You can't sell a stock or mutual fund at a loss and then buy it again it within 30 days just to claim the losses. You'll need to figure the basis for shares sold in a wash sale. When you do, add the amount of disallowed loss to the basis of the shares that caused the wash sale. These are the new shares you received.

What is the wash sale rule for dummies? ›

See the rule in action

Under the wash-sale rule, you cannot deduct a loss if you have both a gain and a loss in the same security within a 61-day period. (That's calendar days, not trading days, so weekends and holidays count.) However, you can add the disallowed loss to the basis of your security.

How is a wash sale calculated? ›

When determining the transactions that are counted as wash sales, the IRS uses the terms “same stocks” or “substantially identical stocks” to determine if investors are claiming artificial losses. Two securities are identified as the same if they are exactly identical or if they share most of their characteristics.

What is an example of a wash sale adjustment? ›

An additional 100 XYZ Company shares for $39 per share at 11:30 a.m. On September 6, you sell 100 XYZ Company shares at $35 per share. This would result in a wash sale because you purchased the identical security in two separate transactions on August 15th and sold some of those shares at a loss within 30 days.

How do you avoid the wash sale? ›

This method is employed as a means of lowering the investor's taxable income. To avoid triggering the wash sale rule, an investor can employ a strategy such as buying more of the stock that they'd like to sell, holding on to the new stock purchase for 31 days, and then selling it.

Can you sell a stock for a gain and buy back immediately? ›

It is always possible to sell a stock for profit purposes, as the Income Tax Department has you paying taxes on the profit you make. This is, as mentioned earlier, a capital gains tax. You can buy the same stock back at any time, and this has no bearing on the sale you have made for profit.

Is it legal to buy and sell the same stock repeatedly? ›

Just as how long you have to wait to sell a stock after buying it, there is no legal limit on the number of times you can buy and sell the same stock in one day. Again, though, your broker may impose restrictions based on your account type, available capital, and regulatory rules regarding 'Pattern Day Traders'.

Can I sell stock and reinvest without paying capital gains? ›

With some investments, you can reinvest proceeds to avoid capital gains, but for stock owned in regular taxable accounts, no such provision applies, and you'll pay capital gains taxes according to how long you held your investment.


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