Avoid violating the IRS wash sale rule for tax losses when you sell and rebuy stocks.
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Be aware of the wash sale rule enforced by the IRS. The rule is important for investors reassessing their market positions and looking to sell and repurchase declining stocks to offset losses.
Disallowed losses are a potential tax pitfall of violating the wash sale rule, so here are six key things you need to know.
Ever sold a stock at a loss and then thought “Hmm maybe I should buy it back now that the price is even lower”? Well, before you hit that “buy” button, there’s something important you need to know about – the IRS wash sale rule. This rule might force you to wait longer than you’d like, or it could mess with your tax strategy if you’re not careful.
I’ve helped many clients navigate this tricky rule, and today I want to share everything you need to know about how long you need to wait before buying back a stock you’ve just sold.
What is the Wash Sale Rule?
The wash sale rule is an IRS regulation designed to prevent investors from creating artificial losses just to reduce their tax bill. It’s basically the government’s way of saying “Nice try but we see what you’re doing there!”
Here’s the important part The wash sale rule states that if you buy the same or a “substantially identical” security within 30 days before OR after selling at a loss you cannot claim that loss on your tax return.
This means you have to wait at least 31 days after selling a stock at a loss before buying it back if you want to claim the tax loss.
The 61-Day Window You Need to Know About
When people talk about the wash sale rule, they often focus on the 30 days after selling. But it’s actually a 61-day window that matters:
- 30 days BEFORE the sale
- The day of the sale
- 30 days AFTER the sale
Let’s break this down with a simple example:
If you sell a stock on July 15th at a loss, the wash sale rule applies if:
- You bought the same or substantially identical stock between June 15th and July 14th (30 days before)
- OR if you buy the same or substantially identical stock between July 16th and August 14th (30 days after)
To safely avoid a wash sale, you need to wait until August 15th (31 days after selling) to repurchase the stock.
Why Should You Care About the Wash Sale Rule?
You might be wondering, “Why is this such a big deal?” Well, here’s why it matters:
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Tax Loss Harvesting: Many investors sell losing investments to offset capital gains and reduce their tax bill. The wash sale rule can prevent you from claiming these losses.
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Disallowed Losses: If you violate the wash sale rule, your loss is “disallowed” – meaning you can’t use it to offset capital gains or deduct it from your income.
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Cost Basis Adjustments: The disallowed loss doesn’t disappear forever – it gets added to the cost basis of the replacement stock. But this means you have to wait longer to realize the tax benefit.
What Exactly Is “Substantially Identical”?
The IRS hasn’t precisely defined what “substantially identical” means, which makes things a bit confusing. But here are some general guidelines:
- Stocks of different companies are usually not considered substantially identical.
- Options on a stock and the underlying stock itself may be considered substantially identical.
- ETFs that track the same index from different companies might be considered substantially identical (like Vanguard’s S&P 500 ETF vs. SPDR’s S&P 500 ETF).
- Mutual funds that track the same index might also be considered substantially identical.
Examples of Wash Sales
Here’s an example to make things clearer:
Let’s say you bought 50 shares of JustaTissueBox stock for $100 per share ($5,000 total). The stock drops to $80 per share, and you sell all 50 shares for $4,000, taking a $1,000 loss.
Two weeks later, you see the stock has dropped even further to $50 per share, and you decide to buy it back. You purchase 50 shares for $2,500.
Unfortunately, you can’t claim that $1,000 loss on your taxes because you bought the same stock back within the 30-day window. This is a classic wash sale.
Exceptions to the Rule
Not all repurchases trigger the wash sale rule. Here are some situations where you might be able to buy similar investments without waiting:
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Different Securities: You can sell stock in Company A and immediately buy stock in Company B (even if they’re competitors in the same industry).
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Sector ETFs: If you sell an individual stock at a loss, you can immediately buy an ETF that includes that stock among many others.
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Different Asset Classes: You can sell a stock and immediately buy bonds or other unrelated investments.
How to Avoid the Wash Sale Rule
If you really want to claim that tax loss, here are your options:
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Wait 31 Days: The simplest approach is to wait at least 31 days after selling before buying the same security back.
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Buy a Similar (But Not Identical) Investment: Instead of buying back the exact same stock, buy something similar but not “substantially identical.” For example:
- If you sold shares of one bank, buy shares of a different bank.
- If you sold an S&P 500 index fund, buy a total stock market fund instead.
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Buy Before You Sell: If you’re planning to sell something at a loss, you could buy more shares more than 30 days before selling the original shares. Just be aware of the risks of doubling down on a losing investment!
The Wash Sale Rule and Retirement Accounts
Here’s something many investors don’t realize: The wash sale rule applies across ALL your accounts, including retirement accounts!
If you sell a stock at a loss in your taxable brokerage account and then buy it back in your IRA within 30 days, that’s still a wash sale. And here’s the kicker – the loss is effectively forfeited because you can’t adjust the cost basis in your IRA.
Does the Wash Sale Rule Apply to Cryptocurrency?
As of my most recent update, the wash sale rule doesn’t apply to cryptocurrency because the IRS classifies crypto as property, not as securities. This creates a potential loophole that allows crypto investors to sell at a loss and immediately repurchase the same cryptocurrency.
However, be aware that tax laws can change, and there have been proposals to extend the wash sale rule to cryptocurrency transactions.
How to Report Wash Sales on Your Taxes
If you do have a wash sale, you’ll need to report it on your tax return using:
- IRS Form 8949
- Schedule D
Most modern brokerages track wash sales for you and report them on your 1099-B tax form. But if you have multiple accounts at different brokerages, you need to track wash sales yourself because each brokerage only knows about transactions within their platform.
Real-World Strategies for Navigating the Wash Sale Rule
Here are some practical strategies I’ve seen investors use:
Strategy 1: Tax-Loss Harvesting with Similar (But Not Identical) Investments
- Sell Stock A at a loss
- Immediately buy Stock B (a similar but not substantially identical company)
- Wait 31 days
- Decide whether to sell Stock B and buy back Stock A, or keep Stock B
Strategy 2: Doubling Up Temporarily
- Buy more of Stock A that you already own (which is currently at a loss)
- Wait 31 days
- Sell your original shares of Stock A at a loss
- Keep the new shares you bought
This strategy is sometimes called a “double-up,” and it allows you to maintain your position while harvesting the tax loss.
Common Mistakes to Avoid
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Forgetting about dividend reinvestments: If you have automatic dividend reinvestment set up, those purchases can trigger the wash sale rule if they occur within 30 days of selling at a loss.
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Not coordinating between accounts: Remember that the rule applies across all your accounts, including your spouse’s accounts.
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Ignoring substantially identical securities: Remember that options, convertible preferred stock, and some ETFs might be considered substantially identical.
Practical Examples of Waiting Periods
Here’s a quick reference for how long you need to wait in different scenarios:
| Scenario | Waiting Period |
|---|---|
| Selling at a loss and buying back same stock | 31 days after sale |
| Selling at a loss after recent purchase | 31 days after purchase |
| Selling at a GAIN | No waiting period required |
| Buying more of a stock you plan to sell at a loss | Purchase must be more than 30 days before OR after the sale |
Final Thoughts
The wash sale rule can be frustrating when you’re trying to manage your investments, but understanding it helps you avoid unexpected tax consequences. Remember, this isn’t just about following rules – it’s about optimizing your investment strategy while staying on the right side of tax law.
If you’re ever unsure about whether a particular transaction might trigger the wash sale rule, it’s always best to consult with a tax professional who can give you personalized advice based on your specific situation.
Have you ever run into issues with the wash sale rule? I’d love to hear your experiences in the comments below!
FAQs About the Wash Sale Rule
Q: If I sell a stock at a gain, do I need to wait before buying it back?
A: No, the wash sale rule only applies to securities sold at a loss.
Q: Can I buy a different number of shares than I sold without triggering the wash sale rule?
A: No, buying even a single share of the same security within the 30-day window will trigger the rule, though it may only apply to a portion of your loss.
Q: What happens if I violate the wash sale rule accidentally?
A: Your loss will be disallowed for current tax purposes, and the amount of the disallowed loss will be added to the cost basis of your replacement shares.
Q: Does the wash sale rule apply if my spouse buys the stock I just sold?
A: Yes, the IRS considers transactions by spouses to be subject to the wash sale rule.
Q: Can I buy call options on a stock I just sold at a loss?
A: No, options to buy the stock are considered substantially identical securities under the wash sale rule.
Remember, the key to avoiding wash sale complications is simple: if you sell an investment at a loss and want to claim that loss on your taxes, wait at least 31 days before buying it back. Your tax bill will thank you!
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Essentially, a wash sale occurs when you sell a security at a loss and then purchase the same security again in a short period.
Note: Losses can offset same-year gains that can ultimately reduce capital gains taxes. Additionally, remaining losses can be deducted from ordinary income (up to $3,000) or carried over to the following tax year. As a result, many people opt to sell securities at a loss to reduce taxable gains, a technique commonly known as tax loss harvesting.
However, the IRS doesn’t like investors to use “manufactured” losses to claim tax breaks. If you sell a stock at a loss and quickly buy it back or keep investing in it after buying it back, the IRS generally won’t allow you to write off the loss on your federal tax return.
Lets consider an example. Suppose you bought 50 shares of a fictional JustaTissueBox stock for $100 per share, and its value dropped to $80 per share.
- You decided to sell all your shares at a loss of $1,000.
- However, two weeks later, the stocks value dropped further to $50 per share, and you bought back 50 shares for $2,500.
- Unfortunately, you cannot claim the $1,000 capital loss on your tax return for that year because the second purchase was a wash sale.