Wash-Sale Rule

The Wash-Sale Rule is a regulation from the U.S. Internal Revenue Service (IRS) that every stock market investor needs to know. Imagine this: you sell a stock to realize a capital loss, which you plan to use to lower your taxes. But, because you still like the company, you buy back the same stock a few days later. The IRS sees this as a “wash”—you didn't truly end your investment position; you just played a little game to get a tax break. The Wash-Sale Rule prevents this by disallowing your claimed loss if you buy a “substantially identical” security within a 61-day window (30 days before the sale, the day of the sale, and 30 days after). The rule doesn't make your loss vanish forever, though. Instead, it gets added to the cost basis of the new shares you bought, effectively postponing the tax benefit until you sell them for good.

Let's break it down with a story. You're an investor named Alex.

1. Step 1: The Purchase. Alex buys 100 shares of a fictional company, “Bright Idea Inc.” (BII), for $20 per share. The total investment is $2,000.
2. Step 2: The Dip. A month later, bad news hits the market, and BII stock drops to $15 per share. Alex’s investment is now worth only $1,500.
3. Step 3: The Sale. Alex decides to sell all 100 shares at $15, realizing a capital loss of $500 ($2,000 - $1,500). Alex thinks, “Great, I can use this $500 loss to offset some of my other investment gains on my tax return!”
4. Step 4: The Re-buy (The Mistake). Two weeks later, Alex's confidence in Bright Idea Inc. returns, so they buy back 100 shares at the new price of $16 per share.
5. Step 5: The Rule Kicks In. Because Alex bought back the same stock within 30 days of selling it for a loss, the Wash-Sale Rule is triggered. The IRS disallows the $500 loss for the current tax year.
6. Step 6: The Adjusted Cost. The disallowed $500 loss isn't lost—it's added to the cost of the new shares. Alex's new cost basis is not $1,600 (100 shares x $16), but $2,100 ($1,600 + the $500 disallowed loss). This means when Alex eventually sells BII in the future, the capital gain will be smaller (or the loss larger), but the immediate tax benefit is gone.

This is the most critical part of the rule. The wash sale is triggered if you buy an identical security:

• 30 days before selling your original shares for a loss.
• The day you sell your original shares for a loss.
• 30 days after selling your original shares for a loss.

Many investors forget about the “30 days before” part. If you buy more shares of a stock you already own and then sell your original shares at a loss within 30 days, you’ve triggered the rule.

This term can be a bit fuzzy, but here’s a simple guide:

• Definitely Identical: Shares of stock in the same company are identical.
• Also Identical: Options or warrants to buy or sell the stock of the same company are considered substantially identical.
• Generally NOT Identical: Stocks of different companies, even if they are in the same industry (e.g., selling Coca-Cola and buying Pepsi), are not identical. Most tax experts also agree that ETFs from different providers that track the same index (e.g., an S&P 500 ETF from Vanguard vs. one from State Street) are not identical, but it's a gray area. When in doubt, it’s best to be cautious or consult a professional.

The IRS is clever. The rule isn't just for one brokerage account. It applies to transactions across all your accounts, including your Traditional IRA or Roth IRA. It even applies to your spouse's accounts. Selling a stock at a loss in your taxable account and then having your spouse buy it in their IRA a week later will trigger the wash-sale rule.

For a value investing practitioner, the Wash-Sale Rule is less of an obstacle and more of a helpful reminder. The goal of a true value investor is to buy wonderful businesses at fair prices, not to play tax-minimization games. A sale should be prompted by a fundamental change in your investment thesis—perhaps the company’s competitive advantage has eroded, its management has made poor decisions, or its intrinsic value has been fully realized. Selling simply to harvest a loss (a strategy known as tax-loss harvesting) can lead to “the tax tail wagging the investment dog.” The rule forces a 31-day cooling-off period. This can be a blessing in disguise, preventing you from emotionally jumping back into a losing position and encouraging you to re-evaluate: “Is this truly the best place for my capital, or is there a better opportunity elsewhere?”

If you've sold a security at a loss and want to claim it on your taxes, you have a few simple options:

• Wait 31 Days: The easiest way. Just wait for the 61-day window to close (meaning at least 31 days after the sale) before repurchasing the same security.
• Buy Something Different: Reinvest your money into a company that is not substantially identical. If you sold a specific bank stock, consider buying a broad financial sector ETF instead.
• Keep Good Records: Your broker will usually track wash sales within a single account and report them on your 1099-B form. However, you are ultimately responsible for tracking wash sales that occur across multiple accounts (e.g., your account and your spouse's).