How Does the Wash Sale 61-Day Rule Work?

The wash sale rule is an Internal Revenue Service (IRS) regulation that impacts investors who sell securities at a loss. Its purpose is to prevent the claiming of tax deductions for losses when an investor has not truly changed their economic position. The rule targets situations where an investor sells a security to realize a loss for tax purposes, only to quickly regain a similar investment. This ensures a claimed capital loss reflects a genuine financial setback.

Core Components of the Wash Sale Rule

A wash sale begins with the sale or trade of a stock or security that results in a capital loss. The rule is triggered when this loss is paired with the acquisition of “substantially identical” securities within a specific timeframe. This loss would normally be deductible against capital gains or other income, but the wash sale rule prevents this.

Securities of the same company are considered substantially identical. For instance, selling shares of ABC Corporation at a loss and then buying new shares of ABC Corporation triggers the rule. The definition also includes contracts or options to acquire or sell the stock, such as call options or warrants. The rule applies across all of a taxpayer’s accounts, including taxable brokerage accounts and tax-advantaged accounts like traditional or Roth IRAs.

The rule also considers the actions of both spouses. If one spouse sells a security for a loss and the other acquires a substantially identical security within the proscribed period, a wash sale is triggered. This applies even if the accounts are separate.

The 61-Day Window Explained

The wash sale rule operates within a 61-day period. This window is calculated as the 30 days before the sale that generates a loss, the day of the sale, and the 30 days after the sale. A purchase of a substantially identical security within this timeframe triggers the rule.

For example, if an investor sells a stock at a loss on March 15, the 61-day window begins on February 13. The window extends through the sale date and concludes on April 14. A purchase of a substantially identical security on any day between February 13 and April 14 would create a wash sale.

It is the acquisition of the replacement security within this window that matters, not when the original security was purchased. The rule can be triggered by buying the new shares before the sale that generates the loss. This “look-back” provision often surprises investors who may only be focused on their actions after selling for a loss.

Calculating the Financial Adjustments

When a wash sale occurs, the loss realized on the sale is disallowed for the current tax year. You cannot use this loss to offset capital gains or reduce your taxable income. The loss is not permanently forfeited but is instead deferred.

This deferral is handled through a cost basis adjustment on the new securities. The disallowed loss is added to the purchase price of the new shares, creating a higher tax basis. For example, imagine you sell 100 shares of XYZ stock for a $1,000 loss and then buy 100 replacement shares for $5,000. The $1,000 loss is disallowed, and your new cost basis becomes $6,000, which is the $5,000 purchase price plus the $1,000 disallowed loss.

This adjustment effectively builds the disallowed loss into the cost of the new investment. When you eventually sell the replacement shares, the higher basis will result in either a smaller capital gain or a larger capital loss. The holding period of the original shares is also added to the holding period of the new shares. This can affect whether a future gain or loss is classified as short-term or long-term.

Reporting Wash Sales on Your Tax Return

A wash sale must be correctly reported to the IRS on Form 8949, Sales and Other Dispositions of Capital Assets. You will report the sale transaction with its original details, such as the dates acquired and sold, and the proceeds.

On Form 8949, you must enter the code “W” in column (f). This code indicates to the IRS that the transaction is a wash sale and the loss is subject to the rule.

Following the entry of the code, you will make an adjustment in column (g), titled “Amount of adjustment.” Here, you enter the amount of the disallowed loss as a positive number. This entry counteracts the calculated loss and modifies the final gain or loss reported in column (h), ensuring the disallowed loss is not factored into your yearly total.