Definition
A wash sale occurs when an investor sells or disposes of stock or securities at a loss and subsequently acquires substantially identical stock or securities within a 61-day period surrounding the sale date. This period includes the day of the sale and extends 30 days before and 30 days after the sale. Under IRS regulations, any loss incurred on a wash sale is not deductible for tax purposes. If, however, the disposition during the 61-day window results in a gain, it does not qualify as a wash sale, and the gain is subject to taxation.
Examples
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Example 1: An investor sells 100 shares of Company XYZ at a loss on March 1 and then buys 100 shares of Company XYZ on March 15. Because the repurchase occurs within 30 days of the sale, any loss recognized from the first sale is disallowed for tax purposes as it constitutes a wash sale.
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Example 2: An investor sells shares of Company ABC at a loss on April 5 and then purchases shares of a mutual fund investing primarily in the same sector on April 8. This scenario could be considered a wash sale if the shares are judged to be substantially identical to those initially sold.
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Example 3: An investor sold shares of Company DEF at a loss on January 1 and repurchased an equivalent number of shares on February 2. Since more than 30 days have passed since the original sale, this would not be considered a wash sale, and the loss would be deductible.
Frequently Asked Questions (FAQ)
What if I repurchase the same stock in a different account or IRA?
The wash sale rule applies regardless of the account used for the transaction. For example, even if the repurchase happens in a different brokerage account or an Individual Retirement Account (IRA), the wash sale rule still applies.
Can I offset wash sale losses against capital gains?
No, the IRS does not allow offsetting wash sale losses against capital gains because the loss itself is disallowed.
How can I avoid triggering a wash sale?
To avoid a wash sale, refrain from repurchasing the same or substantially identical securities within 30 days before or after selling the original securities at a loss.
Are options and derivatives subject to wash sale rules?
Yes, options and derivatives related to the securities sold at a loss are also considered when determining if a transaction is a wash sale.
What happens to the disallowed loss from a wash sale?
The disallowed loss is added to the cost basis of the repurchased securities. This adjustment will affect the future gain or loss when the repurchased securities are eventually sold.
Related Terms
Securities
Financial instruments that represent ownership positions in publicly-traded corporations (stocks), creditor relationships with governmental bodies or corporations (bonds), or rights to ownership (options).
Capital Gains
The profit realized when a capital asset, such as stock or real estate, is sold for a higher price than the purchase price.
Cost Basis
The original value of an asset for tax purposes, usually the purchase price, adjusted for stock splits, dividends, and return of capital distributions.
Tax Deduction
A reduction of taxable income allowed by the IRS for specific types of expenses or losses.
Substantially Identical
Defines investments or securities that are nearly identical in nature and thus cannot be used to claim a loss if repurchased within the wash sale period.
Online References
- IRS Publication 550: Investment Income and Expenses
- Investopedia Wash Sale Definition
- SEC’s Guide to Wash Sales
Suggested Books for Further Studies
- “Taxes Made Simple: Income Taxes Explained in 100 Pages or Less” by Mike Piper
- “The Tax and Legal Playbook: Game-Changing Solutions To Your Small-Business Questions” by Mark J. Kohler
- “A Random Walk Down Wall Street” by Burton G. Malkiel
Fundamentals of Wash Sale: Taxation Basics Quiz
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