A wash sale occurs when an investor sells a security at a loss and then repurchases it within 30 days of the sale. The purpose of this rule is to prevent an investor from creating a deductible capital loss while quickly returning to essentially the same investment.
For example:
January 20
Investor purchases 100 shares at $50
March 15
Investor sells 100 shares at $20
Realized loss of $30 per share ($3,000 overall)
March 16
Investor buys 100 shares at $20
Even though the investor sold at a loss, they repurchased the shares the next day. Economically, they’re back in the same position, but they would otherwise be able to claim a $3,000 deductible loss. The IRS treats this as an improper use of capital loss deductions, so the wash sale rule limits the tax benefit.
The basics of the rule are:
Capital losses are disallowed if security is repurchased within 30 days of the sale
Disallowed loss is added to the cost basis of the new position
Let’s run through an example:
An investor purchases 100 shares of MNO Fund at $50 per share on February 10th. On April 20th, the shares are sold for $28 per share. On May 5th, the investor buys 100 shares of MNO Fund at $30.
In this example, the investor realizes a $22 per share loss on April 20th, for an overall $2,200 capital loss. Fifteen days later, the investor repurchases the fund at $30 per share, which triggers the wash sale rule.
The $22 per share loss is disallowed and can’t be used as a tax deduction at that time.
The loss doesn’t disappear, though. Instead, the disallowed loss is added to the cost basis of the new shares. That higher cost basis reduces taxable gain (or increases loss) when the new shares are eventually sold.
New purchase price: $30 per share
Disallowed loss added to basis: $22 per share
New cost basis: $52 per share ($30 + $22)
If the investor later sells at $30 per share, they would report a $22 per share loss ($30 sales proceeds vs. $52 cost basis). If the investor does not repurchase the shares again within 30 days of that later sale, the loss can be claimed.
The wash sale rule applies to repurchases of the same security, or even a similar security. The IRS refers to these as “substantially identical securities.” For stock, this includes:
*Rights and warrants are derivative securities that provide the right to buy stock at a fixed price. Other than discussing their impact on wash sales, we do not expect you to encounter any Series 6 test questions on these securities. If you’re curious, you can review their characteristics on the Achievable Series 7 program.
A helpful way to think about this: if a security gives you a straightforward way to obtain the stock (such as converting or exercising), the IRS generally treats it like buying the stock itself.
For bond wash sales, it’s a bit different. If an investor repurchases a bond within 30 days of selling a bond at a loss, they can avoid the wash sale rule if two of the following three items on the new bond are different:
Coupon
Maturity
Issuer
The 30-day wash sales period applies before and after the loss is realized. This prevents investors from “front-loading” shares. For example:
An investor purchases 100 shares of AXP Fund at $90 per share on August 20th. On October 1st, 100 more shares of AXP Fund are purchased at $76. The next day, the shares are sold for $73 per share.
Before selling at a loss, the investor purchased an additional 100 shares. On October 2nd, they sell the original 100 shares (assuming FIFO; see below additional information on FIFO) for a $17 loss ($73 sales proceeds vs. $90 cost basis). Because additional shares were purchased the previous day (within the 30-day wash sale window), the $17 loss is disallowed and added to the cost basis of the current position.
Current shares cost basis becomes $93 per share ($76 cost basis + $17 disallowed loss)
If the investor sells these shares later, they can claim any realized loss as long as they do not repurchase the shares again within 30 days of that later sale.
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