The wash sale rule explained: How it impacts your taxes and investments

What is the wash sale rule?

The wash sale rule is a restriction under the tax code that determines whether you can claim an investment loss on your taxes. Offsetting investment gains with losses is a strategy that can help reduce the impact of market volatility as you grow your money. However, some losses are not eligible. This rule was established in 1921 to prevent investors from taking advantage of the tax code by creating artificial losses by selling a stock at a loss and repurchasing it to realize gains.

How does the wash sale rule work?

The wash sale rule prevents a tax-loss claim if you buy the same or a substantially identical security within the 61-day window surrounding the sale. This window includes:

• The 30 days before the sale,
• The day of the sale, and
• The 30 days after the sale

For example, let’s say you buy 100 shares of JLM stock for $10 per share, for a total cost of $1,000. The price later falls to $5 per share, and you buy another 100 shares for $500. If you then sell your original 100 shares 20 days later for $500, you would have a $500 realized loss. However, because you purchased substantially identical shares within 30 days before the sale, the wash sale rule applies, and you generally cannot claim that $500 loss for the year of the sale.

Similarly, the rule can also apply when the repurchase happens after the sale. Let’s say you purchase 100 shares of JLM stock at $10 per share, sell them at $5 per share, then repurchase 100 more JLM shares 15 days later at the lower price. In this case, you generally cannot claim the $500 loss in the year of the sale. Although in both examples the loss is disallowed for that year, it may still provide a future tax benefit (more on that later).

Securities affected by the wash sale rule

The wash sale rule generally applies to certain securities transactions, which may include:

• Stocks
• Bonds
• Exchange-traded funds (ETFs)
• Mutual funds
• Options
• Securities with a Committee on Uniform Securities Identification Procedures (CUSIP) number, a nine-character code assigned to financial instruments that are traded in the United States and Canada.

Examples of sales covered by the wash sale rule

The wash sale rule is applied across a wide range of transactions and across all your accounts. Here are some examples of sales that can trigger the rule:

• You sell an ETF at a loss, then your spouse purchases the same ETF 20 days later.  
• An investor sells a stock at a loss and then acquires a call option on it a week later.
• Stock was sold at a loss and substantially similar stock was repurchased a day after the sale.
• Last week, you sold shares in a mutual fund you’ve owned for over a decade. Four days later, an automatic purchase order on your brokerage account purchases shares of the same mutual fund without your knowledge.

Impact on capital gains and losses

Although you can’t offset your capital gains with a wash sale loss in the year the loss occurred, you could see some tax benefits later. You can add the loss amount to the cost of the securities that triggered the rule, resulting in an adjusted cost basis.

Sale price of repurchased stock + disallowed loss = adjusted cost basis

This increase in cost basis may help offset future taxable gains when the securities are sold. Or, if sold at a loss, the higher cost basis may allow you to claim a larger loss on your taxes.

Let’s look at the previous example of the $500 loss. Despite the stock’s previous performance, you decide to repurchase 100 shares the following year at $3 per share. You can add the previously disallowed $500 loss to the $300 repurchase price, resulting in an adjusted cost basis of $800. If you sold these shares a few months later for $1,000, your capital gains tax would be based on a gain of $200 ($1,000 sale price – $800 adjusted cost basis) rather than $700 ($1,000 sale price – $300 cost). Although you could not claim the $500 loss in the year of the original sale, adding it to the cost basis of the replacement shares reduced your capital gain in a later sale.

Carrying forward a disallowed loss may also provide a larger tax shield if the price of the repurchased stock continues to fall. If you sell the new shares at $200, you would be able to claim a $600 loss ($300 purchase price + $500 disallowed loss – $200 sale price) instead of a $100 loss ($300 – $200 sale purchase price).

Impact on taxable vs. tax-deferred accounts

If you sell shares of a taxable investment like a mutual fund at a loss, then repurchase the same or a substantially identical investment within a tax-deferred account like an IRA during the 61-day wash sale window, the loss generally becomes permanent. You cannot add the loss to the repurchased investment for an adjusted cost basis, nor can you tack on the holding period of the original investment.

How to avoid wash sales

Brokerage firms report wash sales to the IRS. However, they are not required to track wash sales across different accounts. The investor is ultimately responsible for proper reporting. When planning to sell an investment, especially if you’re selling for tax-loss harvesting purposes, it’s a good idea to review your investment timeline and check the purchase date first. It’s best to wait at least 31 days after a loss if you plan to repurchase the same investment.

Alternative investment options during the wash sale period

If you want to avoid triggering the wash sale rule, but don’t want to keep your money out of the market while you wait for the 61-day restriction period to expire, you should ensure that you do not purchase the same or a substantially identical security to the one you sold. For example, if you sell a mutual fund that is focused on the technology sector, repurchasing shares of a fund that focuses on real estate may not trigger the wash sale rule. The IRS has not provided detailed guidelines around what constitutes substantially identical. Consulting with a financial or tax professional can help you ensure correct tax reporting.

Reporting wash sales and disallowed losses on your taxes

If your investment activity results in a wash sale, you are required to report the sale on IRS Form 8949.

Record-keeping best practices for investors

The following methods can be used to help ensure proper reporting of wash sales and disallowed losses:

• Manually tracking your sales and purchases across all your securities accounts
• Reviewing your year-end IRS Form 1099-B, specifically Box 1g (however, you should not rely solely on this form, especially if you trade across several accounts and institutions)
• Using spreadsheets or portfolio tracking tools to help you monitor purchase dates, sale dates, CUSIP numbers, gains, losses, and possible violations

Consequences of failing to report wash sales correctly

Failing to report wash sales correctly can result in the underpayment of taxes, which would require you to amend your tax return. You may need to pay taxes on any amounts that were incorrectly excluded. Fees and penalties may also apply.

Common wash sale mistakes investors make

Filing taxes can be complicated. It’s wise to seek the help of a tax professional when preparing your returns. Some common wash sale mistakes include:

Accidental wash sales caused by auto‑investing

Auto investing involves authorizing a broker or investment software to sell or purchase securities on your behalf when certain criteria are met. With these protocols in place, it’s possible for a wash sale to occur without you realizing it.

Assuming brokers catch every wash sale

Although brokers are required to report wash sales within the same account, they generally do not track wash sales across multiple accounts. You are ultimately responsible for monitoring transactions across all your accounts.

Believing wash sale losses are gone forever

Generally, wash sale losses can be added to the cost basis of the repurchased investment. The holding period of the original investment can also be tacked on to the holding period of the newly purchased investment. Not taking advantage of these provisions can mean leaving certain tax advantages on the table.

While the wash sale rule can delay when you claim a loss, it doesn’t always erase the tax benefit entirely. Careful monitoring of your trades and understanding how the IRS treats wash sales can help you to maximize your tax advantages.

Wash sale rules FAQs