Does the Wash-Sale Rule Apply to Your Roth IRA? Here’s What You Need to Know

Understanding the Wash-Sale Rule and Its Impact on Your Retirement Accounts

If you’re like me, trying to navigate the complex world of tax rules while managing your investments can feel overwhelming. One question I get asked frequently is whether the wash-sale rule applies to Roth IRAs. The short answer is yes—and it’s more complicated than you might think.

I’ve been helping clients with their retirement strategies for years, and this issue continues to cause confusion. Let’s break it down in simple terms so you can avoid potentially costly mistakes with your investment strategy.

What Exactly Is a Wash Sale?

Before diving into how this affects your Roth IRA, we need to understand what a wash sale actually is.

A wash sale occurs when you sell shares of a stock at a loss and then buy the same or “substantially identical” stock within 30 days before or after the sale. The IRS created this rule to prevent investors from creating artificial losses just to reduce their tax bill.

Here’s a simple example

• You own 100 shares of ABC Company with a basis of $2,000
• You sell those 100 shares on March 21 for $1,000 (a $1,000 loss)
• You buy 100 shares of the same ABC Company on March 22 for $600

In this scenario you’ve triggered a wash sale. You cannot deduct that $1000 loss on your taxes. However, you can add the loss of $1,000 to your new purchase price of $600, giving you a new basis of $1,600.

The wash-sale rule applies to various securities including:

• Stocks
• Bonds
• Mutual funds
• Options

Do Wash-Sale Rules Apply to IRAs?

This is where things get interesting (and potentially confusing). For years, there was uncertainty about whether wash-sale rules applied across different account types, especially retirement accounts like IRAs.

In 2008, the IRS cleared up this confusion with “Revenue Ruling 2008-5.” This ruling specifically addressed whether wash-sale rules apply to IRAs, and the answer was a definitive yes.

According to this ruling, if you sell shares in a non-retirement account (like a regular brokerage account) at a loss and then purchase substantially identical shares in an IRA (including a Roth IRA) within 30 days, you cannot claim the tax loss for the sale. Moreover—and this is crucial—the basis in your IRA is not increased.

The Roth IRA Wash-Sale Rule in Action

Let’s look at how this works specifically with a Roth IRA:

Example:

• You own 100 shares of YYY stock with a basis of $1,000 in your regular brokerage account
• You sell these shares at a loss for $400 on October 10 (a $600 loss)
• On November 1 (within the 30-day window), you buy 100 shares of the same YYY stock in your Roth IRA for $800

According to the IRS ruling:

1. You cannot deduct the $600 loss on your taxes
2. You cannot increase the basis of the stock purchased in your Roth IRA

This is particularly significant with a Roth IRA because, unlike traditional IRAs, Roth IRAs are funded with after-tax dollars. The loss is essentially permanently disallowed.

Why This Matters for Your Roth IRA

The implications are serious for Roth IRA investors. While normally you wouldn’t worry about basis in a Roth IRA (since qualified distributions are tax-free anyway), there are situations where basis becomes relevant:

1. Early withdrawals: If you take non-qualified distributions from your Roth IRA, the wash sale could affect how much is taxable
2. Tax-loss harvesting: Many investors use tax-loss harvesting as a strategy to offset gains, but this strategy can be undermined if you’re not careful about wash-sale rules across all your accounts

One thing that makes the Roth IRA situation unique is that wash sales that happen between a taxable account and your Roth IRA permanently disallow the actual losses that occurred in your taxable account. There’s no way to recapture that tax benefit later.

Common Misconceptions About Wash Sales and Roth IRAs

I’ve noticed several misconceptions that investors have about wash sales and Roth IRAs:

Misconception #1: “I can sell a stock at a loss in my regular account and immediately buy it in my Roth IRA to claim the tax loss.”

Reality: This is exactly what the wash-sale rule prevents. The loss will be disallowed.

Misconception #2: “Wash-sale rules only apply within the same account type.”

Reality: The rules apply across all accounts you own or control, including your spouse’s accounts.

Misconception #3: “Wash sales only apply to identical securities.”

Reality: They apply to “substantially identical” securities, which includes options on the same stock or very similar mutual funds.

How to Avoid Violating the Wash-Sale Rule with Your Roth IRA

Here are some practical strategies I recommend to my clients to avoid triggering unwanted wash sales:

1. View all investments as a single portfolio regardless of account type. Plan tax-related transactions with your entire holdings in mind.

2. Wait more than 30 days before or after selling a security at a loss before purchasing it in your Roth IRA.

3. Buy different but similar investments if you want to maintain a certain allocation. For example, if you sell one utility stock at a loss, buy a different utility stock in your Roth IRA rather than the identical one.

4. Use automatic investments with caution. If you have regular automatic purchases set up in your Roth IRA, be careful about what you sell in your taxable accounts.

5. Keep good records of all your transactions across accounts. This is crucial if you ever face an IRS audit.

6. Consider placing volatile investments outside of IRAs where you can take advantage of tax benefits from gains and losses. Use your Roth IRA for dividend-paying investments where the tax-free growth can be maximized.

What Happens If You Break the Rule?

If you accidentally trigger a wash sale between your taxable account and your Roth IRA, you won’t face a penalty per se, but:

1. Your claimed loss will be disallowed if audited
2. You’ll have to pay the capital gains taxes that would have been due
3. Unlike with traditional wash sales in taxable accounts, the disallowed loss doesn’t get added to your basis in the Roth IRA

An IRS audit can result in fines, so if you think you might have violated wash-sale rules in the past, I strongly suggest consulting with a tax professional. You might need to amend previous tax returns.

Real-World Example: Tax-Loss Harvesting Gone Wrong

One of my clients, let’s call him Mark, tried to be clever with his investments near year-end. He sold some underperforming tech stocks in his brokerage account to harvest the tax losses. Then, believing these stocks would rebound, he immediately purchased the same shares in his Roth IRA.

When tax season came, he was surprised to learn he couldn’t deduct those losses. Not only that, but the loss couldn’t increase his basis in the Roth IRA either. It was a double whammy – he couldn’t claim the current tax benefit, and he couldn’t “save” the loss for future use.

Special Considerations for Married Couples

If you’re married, the wash-sale rule gets even more complicated. The rule applies to securities purchased by your spouse as well. This means if you sell a stock at a loss in your individual account, and your spouse purchases the same stock in their Roth IRA within 30 days, it’s still considered a wash sale.

The key is communication between spouses about investment activities, especially near tax time when tax-loss harvesting is common.

Frequently Asked Questions About Wash Sales and Roth IRAs

Can I sell a stock and buy it again within 30 days?

Yes, you absolutely can. You just can’t claim the loss on your taxes if you do. The transaction itself is perfectly legal; it’s the tax deduction that’s disallowed.

What investments are subject to the wash-sale rule?

The wash-sale rule applies to stocks, bonds, mutual funds, exchange-traded funds (ETFs), and options. It even applies if the repurchased security is “substantially identical” to the sold security.

Do wash-sale rules apply between my traditional IRA and Roth IRA?

Yes. The wash-sale rule applies across all accounts you own or control, including between different types of IRAs.

How can I still maintain my investment strategy while avoiding wash sales?

Consider buying similar but not identical securities. For example, if you sold shares of one S&P 500 index fund at a loss, you could buy a different S&P 500 index fund from another company within 30 days without triggering a wash sale.

The Bottom Line

The wash-sale rule definitely applies to transactions involving Roth IRAs, and the consequences can be significant. Since 2008, the IRS has made it clear that selling at a loss in a taxable account and rebuying in any IRA (including a Roth) within 30 days will trigger a wash sale.

What makes this particularly impactful for Roth IRAs is that you permanently lose the tax benefit of the loss. Unlike with traditional wash sales between taxable accounts, you can’t add the disallowed loss to your basis in the Roth IRA.

My advice? Keep track of all your investment accounts as one portfolio when planning tax strategies. When in doubt, wait more than 30 days before repurchasing securities in your Roth IRA that you’ve sold at a loss elsewhere. And if your tax situation is complex, work with a qualified tax professional who understands these nuanced rules.

Remember, smart tax planning is about seeing the big picture across all your accounts—not just focusing on each account in isolation. Your future retired self will thank you for being careful now!