A wash sale occurs when you sell a stock, bond, mutual fund, or other security at a loss and then purchase the same or a substantially identical security within 30 days before or after the sale.
The IRS wash sale rule is designed to prevent taxpayers from creating a deductible loss while maintaining essentially the same investment position.
When a wash sale occurs, the loss isn't permanently lost. Instead, the deduction is postponed until the replacement investment is eventually sold in a qualifying transaction.
How the Wash Sale Rule Works
The wash sale rule applies when both of the following occur:
- You sell a security at a loss.
- You acquire the same or a substantially identical security within the wash sale period.
The replacement purchase can occur in:
- A taxable brokerage account
- Certain retirement accounts
- An account owned by a spouse in some situations
Because the rules can be broader than many investors realize, it's important to review all related purchases when determining whether a wash sale occurred.
Understanding the 30-Day Wash Sale Window
The wash sale period spans a total of 61 days and includes:
- The 30 days before the sale
- The day of the sale
- The 30 days after the sale
If a substantially identical security is purchased during any part of this period, the wash sale rule may apply.
For example:
- Sale at a loss: June 15
- Wash sale window: May 16 through July 15
A purchase within any part of that period can trigger the wash sale rule.
What Happens When a Wash Sale Occurs?
When a wash sale is triggered:
- The loss is not deductible in the year of the sale.
- The disallowed loss is added to the basis of the replacement security.
- The holding period of the original security carries over to the replacement security.
- The loss is deferred until the replacement security is sold in a transaction that is not subject to another wash sale.
The IRS doesn't eliminate the loss; it simply postpones recognition of the loss.
Example of a Wash Sale
Suppose an investor:
- Purchases stock for $1,000
- Sells the stock for $700
- Realizes a $300 loss
- Repurchases the same stock within 30 days for $750
Because the repurchase occurred within the wash sale period:
- The $300 loss is disallowed for the current tax year.
- The $300 loss is added to the basis of the replacement shares.
New basis calculation:
$750 purchase price + $300 deferred loss = $1,050 adjusted basis
When the replacement shares are eventually sold, the deferred loss will generally be recognized through the adjusted basis calculation.
What Does "Substantially Identical" Mean?
The IRS doesn't provide a precise definition for every situation, but substantially identical securities generally include:
- The same stock repurchased shortly after sale
- Shares of the same mutual fund
- Additional shares acquired through dividend reinvestment plans
- Certain options or contracts involving the same security
Determining whether two investments are substantially identical can become complex, particularly with exchange-traded funds (ETFs), mutual funds, options, and similar investments.
How Wash Sales Are Reported
Wash sales are reported on tax forms used to track capital gains and losses.
Form 8949
The sale that generated the wash sale is reported on Form 8949.
Generally:
- The sale proceeds are reported normally.
- The basis is reported normally.
- Code W is entered in the adjustment code column.
- The amount of the disallowed loss is entered as an adjustment.
These adjustments prevent the disallowed loss from being currently deducted.
Schedule D
Information from Form 8949 flows to Schedule D, Capital Gains and Losses.
Schedule D combines:
- Capital gains
- Capital losses
- Wash sale adjustments
- Other investment transactions
The resulting amount is included in the taxpayer's overall capital gain or loss calculation.
How Brokerages Report Wash Sales
Many brokerage firms track wash sales and report them on Form 1099-B.
A brokerage may show:
- Wash sale adjustments
- Adjusted basis information
- Disallowed loss amounts
However, brokerage reporting is not always complete.
For example, brokerages may not track wash sales across:
- Different brokerage firms
- Joint and individual accounts
- Certain spousal accounts
- Some retirement accounts
Taxpayers remain responsible for reporting wash sales correctly even if they are not fully reflected on a brokerage statement.
What About the Replacement Security?
The replacement purchase itself is not reported as a wash sale transaction.
Instead:
- The replacement security receives the adjusted basis.
- The replacement security receives the appropriate holding period adjustment.
- The deferred loss becomes relevant when the replacement security is eventually sold.
At that future sale, the adjusted basis helps preserve the tax benefit of the deferred loss.
Wash Sales and Retirement Accounts
Special care should be taken when purchasing replacement securities inside retirement accounts.
In certain situations, a wash sale involving an IRA may permanently disallow the loss rather than merely defer it.
Because these transactions can have significant tax consequences, taxpayers should review brokerage records carefully when retirement accounts are involved.
How to Avoid a Wash Sale
Investors who want to recognize a capital loss often avoid wash sales by:
- Waiting more than 30 days before repurchasing the security
- Purchasing a different investment that is not substantially identical
- Reviewing dividend reinvestment activity that could create unintended replacement purchases
Many investors don't realize that small automatic purchases within the wash sale window can trigger the rule.
Why Wash Sales Matter
Wash sales can affect:
- Capital gain and loss calculations
- Tax-loss harvesting strategies
- Cost basis records
- Investment tax planning
Properly tracking wash sales helps ensure capital losses are reported correctly and prevents IRS adjustments or notices related to investment transactions.