What Is a Wash Sale? A wash sale occurs when you sell or trade a stock or securities at a loss and within 30 days of the sale (either before or after), you purchase the same—or a "substantially identical"—investment.
A wash sale occurs when an investor closes out a position at a loss and buys the same security (or a substantially similar one) within the 61-day wash sale period. The IRS views this activity as creating artificial losses for tax breaks.
There are instances where investors buy stocks after a wash sale, with the number of purchased stocks being more than the ones sold. In such a scenario, the wash sale regulation does not apply, given the number of stocks not identical to what they sold in the wash sale.
Like many things in tax law, there is no 'statutory' timeframe to avoid a 'wash sale', as it generally comes down to whether or not the dominant purpose of the transaction is designed to derive a tax benefit. If that's the case, then there's always a risk and will be open for the ATO to take it to task," says Lewis.
How to avoid a wash sale. One way to avoid a wash sale on an individual stock, while still maintaining your exposure to the industry of the stock you sold at a loss, would be to consider substituting a mutual fund or an exchange-traded fund (ETF) that targets the same industry.
Most investors run into the wash sale rule only occasionally. If you're an active trader, you're likely to have a large number of wash sales each year.
Investments Subject to Wash Sale Rules
When an investor holds several different investment accounts, wash-sale rules apply to the investor, rather than a specific account. The IRS requires that brokers track and report any sales of the same CUSIP number in the same non-qualified account.
Two Ways to Beat the Rule
One way to defeat the wash sale rule is with a “double up” strategy. You buy the same number of shares in the stock you want to sell for a loss. Then you wait 31 days to sell the original batch of shares.
To avoid a wash sale, you could replace it with a different ETF (or several different ETFs) with similar but not identical assets, such as one tracking the Russell 1000® Index. That would preserve your tax break and keep you in the market with about the same asset allocation.
If you have a wash sale, however, you cannot claim the write-off until you finally sell the asset and avoid repurchasing it for at least 30 days. After that period, you can re-buy the asset without triggering the wash-sale rules.
Essentially, a wash sale occurs when you sell a security at a loss and then purchase the same security again in a short period.
If you decide to harvest some losses in your portfolio by selling individual stocks, you're safe from triggering a wash sale as long as you don't purchase the same exact stock shares within 30 days before or after the realized loss.
If the customer sells 200 shares at a loss but has bought the same security within 30 days before or 30 days after the sell, then the sale is a wash sale. If the buy was for 100 shares, only the loss on 100 of the 200 share sale is disallowed and applied to the replacement shares.
The wash sale period for any sale at a loss consists of 61 days: the day of the sale, the 30 days before the sale and the 30 days after the sale. (These are calendar days, not trading days.
Under the wash-sale rule, you cannot deduct a loss if you have both a gain and a loss in the same security within a 61-day period. (That's calendar days, not trading days, so weekends and holidays count.) However, you can add the disallowed loss to the basis of your security.
The wash sale rules say you can't deduct an investment loss when, within 30 days of the sale, you replace the investment with one that is the same or “substantially identical.” The loss deduction isn't disallowed forever. It's only deferred.
The wash sale rule still applies to these traders. The tax implications for day traders are complex, so it's best to consult a tax professional if you're day trading.
The wash sale rule prohibits an investor from taking a tax deduction if they sell an investment at a loss and repurchase the same investment, or a substantially identical one, within 30 days before or after the sale.
If you can lay the price graph for your new investment on top of the price graph for the old one and never see a significant disparity (as would be the case for two high quality S&P 500 funds), the investments should be considered substantially identical for purposes of the wash sale rule.
Retail investors can buy and sell stock on the same day—as long as they don't break FINRA's PDT rule, adopted to discourage excessive trading.
Your loss is a "wash" in this scenario, just as though you had held your original shares without selling. The tax benefit of your capital loss isn't gone forever, but it's deferred.
To detect Wash Trading, firms should look out for unusual or atypical trading patterns among their traders – buying and selling in a brief time period that has no impact on the position or PNL of the entity.
Wash Sale Penalty
A wash sale itself is not illegal. Claiming the tax loss on a wash sale is, however, illegal. The IRS does not care how many wash sales an investor makes during the year. On the other hand, it will disallow the losses on any sales made within 30 days before or after the purchase.
A study of eToro day traders found nearly 80% of them had lost money over a 12-month period, and the median loss was 36%.
It is an important statistic to consider when evaluating the potential of day trading as an investment strategy. Over 85% of active day traders fail in their first year due to poor risk management.