Key takeaways
- You can’t deduct a loss from the sale of stock or other securities if you acquire substantially identical stock or securities within 30 days before or 30 days after the sale.
- Whether stock or securities are “substantially identical” depends on all the facts and circumstances of your particular case.
- The wash sale rule doesn’t apply to cryptocurrency trading.
- Wash sales are reported to the IRS on Form 8949.
When you lose money on the sale of stock or other securities, you can generally use the loss to reduce your taxable income. However, the wash sale rule prevents investors from “manufacturing” tax losses by selling stock or other securities at a loss and then quickly repurchasing them (e.g., to end up with the same investments as before the sale). If the rule is broken, you can’t use the loss to reduce taxable income.
The goal is to stop investors from manipulating the tax system to their advantage, and to ensure that they’re not claiming losses on transactions that don’t represent true economic losses.
What is the wash sale rule?
On its surface, the wash sale rule isn’t very complicated. It simply states that you can’t sell shares of stock or other securities for a loss and then buy substantially identical shares within 30 days before or after the sale (i.e., for a 61-day period, since you count the day of the sale). If you do, the loss is disallowed for tax purposes.
For example, if you sell 100 shares of stock for a loss and then buy 100 shares of the same stock two days later, you can’t claim the loss on your tax return for that year. Since bonds, exchange-traded funds (ETFs), and mutual funds are considered securities, any loss is also disallowed if you cash out one of these securities and repurchase the same bond or fund within the 61-day period.
However, the wash sale rule gets a bit more tricky when you start looking at the details. For example, how do you determine if stock or securities you want to buy are “substantially identical” to the stock or securities you sell? Does the rule apply to all stock sales and purchases? What if my spouse buys substantially identical stock? What happens if a loss is disallowed? How do you report a wash sale to the IRS?
Let’s take a closer look at these questions and others.
What does “substantially identical” mean for wash sale rule purposes?
There’s no one-size-fits-all definition of what’s “substantially identical” for purposes of the wash sale rule. Instead, whether stock or securities are substantially identical is based on the unique facts and circumstances of your situation.
Generally speaking, if you don’t repurchase the exact same stock or securities, there’s a good chance you’ll avoid the wash sale rule. However, that’s certainly not always the case. For instance, stocks or securities of one corporation generally aren’t considered substantially identical to stocks or securities of another corporation. But the IRS says that stocks and securities of the predecessor and successor corporations involved in a reorganization can be substantially identical.
Likewise, preferred stock typically isn’t considered substantially identical to the same corporation’s common stock. But, according to the IRS, where preferred stock is convertible into the same corporation’s common stock, the preferred and common stock can be substantially identical based on their relative values, price changes, voting rights, dividend restrictions, and other circumstances.
What sales and purchases are subject to the wash sale rule?
If you sell stock or securities for a loss, the wash sale rule applies if you acquire one of the following within 30 days before or after the sale:
- Substantially identical stock or securities in a fully taxable trade,
- A contract or option to buy substantially identical stock or securities, or
- Substantially identical stock or securities for your individual retirement account (IRA).
The wash sale rule also applies to a loss from a short sale if you sell substantially identical stock or securities within 30 days before or 30 days after the short sale is complete. The rule also kicks in if you enter into another short sale of substantially identical stock or securities within that same time period.
However, not every sale and repurchase of stock or securities is subject to the wash sale rule. For example, the wash sale rule doesn’t apply if you sell stock or securities for a gain. So, if you profit from the sale of stock or securities, you can repurchase the same stock or securities right away without any penalty.
The wash sale rule also doesn’t apply to:
- Sales and trades of commodity futures contracts or foreign currencies,
- Traders in the business of buying and selling securities who use the mark-to-market method of accounting,
- Securities dealers if their loss is from a transaction made in the ordinary course of business, or
- Shares redeemed in a floating-NAV (net asset value) money market fund.
Does the wash sale rule apply to cryptocurrency?
The wash sale rule only applies to the buying and selling of stock or other securities. While cryptocurrency is considered “property,” it isn’t stock or a security. As a result, the wash sale rule currently doesn’t apply to cryptocurrencies, such as Bitcoin, Ethereum, Tether, or Solana.
Does the wash sale rule apply if my spouse buys substantially identical stock?
Yes, the wash sale rule applies if you sell stock and your spouse buys substantially identical stock within 30 days before or after the sale.
How does the wash sale rule work if you don’t buy and sell the same amount of stock?
If you sell stock or securities for a loss, then buy back a different amount of substantially identical stock or securities within the 61-day period, you must match the shares bought with an equal number of the shares sold to apply the wash sale rule.
For example, suppose you buy 100 shares of stock on Feb. 1 for $4,000, 50 shares of substantially identical stock on April 13 for $1,800, and 25 more shares of substantially identical stock on April 20 for $1,100. On May 3, you sell the 100 shares you purchased in February for $3,000, which generates a $1,000 loss. However, since you purchased 75 shares of substantially identical stock within 30 days before the sale, you can’t deduct the loss on 75 of the 100 shares you sold on May 3 (i.e., $750 of the loss is disallowed). You can still deduct the remaining loss ($250) from the other 25 shares.
What happens if the wash sale rule is broken?
You might owe capital gains tax if you sell stock or other securities for a profit. However, if you lose money on the sale, the loss can be used to offset (i.e., reduce) the gains from other sales of capital assets.
Plus, if your losses are greater than your capital gains, up to $3,000 of the excess amount (up to $1,500 for married people filing separate returns) can be used to offset “ordinary” taxable income, such as wages, tips, interest, pension payments, and the like.
If you have more than $3,000 (or $1,500) in excess losses, the rest can be used to offset gains or ordinary income on future tax returns.
TurboTax Tip: Since the capital gains tax rate is lower if you hold an asset for more than one year (i.e., for a long-term capital gain), any extra time added to the new stock or securities’ holding period could push it past the one-year mark and result in a lower tax bill if you sell the new stock or securities within one year or less.
However, if you violate the wash sale rule, any loss from the sale of stock or securities is disallowed for tax purposes and can’t be deducted from your capital gains or ordinary income.
A disallowed loss is not completely wasted, though. It’s added to the basis of the substantially identical stock or securities that you buy, which means the taxable gain will be lower (or you might even generate another loss) when the new stock or securities are eventually sold.
The amount of time you owned the stock or securities you sold is also added to the new stock or securities’ holding period, which determines whether you have a long-term or short-term capital gain or loss when the new stock or securities are sold.
Does the wash sale rule impact tax-loss harvesting?
“Tax-loss harvesting” is a common strategy used by investors to lower their capital gains tax. Basically, if an investor has (or expects to have) capital gains for the year, he or she will sell off other assets that have lost value. The loss generated by the sale is then used to offset capital gains and, possibly, be deducted from ordinary income. This strategy is often (but not always) used late in the year as part of the investor’s year-end tax planning.
As discussed above, losses are disallowed for tax purposes if you violate the wash sale rule. So, you must follow the wash sale rule if you plan to use the tax-loss harvesting strategy. Otherwise, you’ll lose the ability to offset or deduct your losses, which is the whole point of the strategy.
How can you avoid the wash sale rule?
There are two main ways to avoid the wash sale rule. First, delay buying substantially identical stock or securities so that your purchase doesn’t fall within the 61-day waiting period. You might not get the price you want on the substantially identical assets, but at least you’ll retain the ability to offset gains or ordinary income with your loss.
Second, avoid purchasing substantially identical stock or securities after generating a loss. If you want to make another purchase within the 61-day period, find something that is different from the stock or securities you sold. Remember that the assets you sell can be similar to the assets you buy without violating the wash sale rule. For instance, you can sell a tech-based mutual fund and then buy a tech-based ETF right away without breaking the rule.
How do you report a wash sale loss?
If you can’t avoid the wash sale rule and end up with a non-deductible loss, report the related sale or exchange in Part I or Part II of Form 8949. Don’t forget to enter “W” in column (f) and follow the directions for Code W in the form instructions.
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