The Wash Sale Rule’s 30-Day Window Explained

The wash sale rule is an Internal Revenue Service (IRS) regulation that impacts investors who sell securities at a loss. This rule prevents taxpayers from claiming a capital loss on the sale of a security if they acquire a “substantially identical” one within a specific timeframe. The purpose of this regulation is to prevent investors from generating artificial tax deductions by ensuring a claimed loss reflects a genuine change in the taxpayer’s holdings, not just a temporary sale to harvest a tax loss.

The 61-Day Window Explained

The timeframe for the wash sale rule is often called the “30-day window,” but this simplifies a more extended period. The rule covers a 61-day period, which includes the 30 calendar days before the sale, the day of the sale, and the 30 calendar days after the sale. This entire period is what the IRS examines to determine if a wash sale has occurred.

To illustrate, consider an investor who sells a stock at a loss on June 15th. The wash sale window for this transaction begins on May 16th (30 days before the sale) and ends on July 15th (30 days after the sale). If this investor purchases the same or a substantially identical stock during this period, the loss from the June 15th sale cannot be deducted. This applies even if the repurchase was unintentional, such as through an automatic dividend reinvestment plan.

The 61-day window applies regardless of the calendar or tax year. For example, if an investor sells a security at a loss on December 15th and repurchases it on January 10th of the following year, the wash sale rule is still triggered. The loss from the December sale would be disallowed because the repurchase occurred within 30 days of the sale, even though the transactions occurred in different years.

Calculating the Tax Impact of a Wash Sale

When a wash sale occurs, the capital loss is disallowed for the current tax year. This means the investor cannot use that loss to offset capital gains, which could result in a higher tax liability. The loss is not permanently forfeited but is instead deferred.

The disallowed loss is added to the cost basis of the newly acquired, or replacement, securities. This adjustment postpones the tax benefit of the loss until the replacement securities are sold. By increasing the cost basis, the future capital gain will be smaller, or the future capital loss will be larger, upon the eventual sale of the new securities.

For example, an investor buys 100 shares for $5,000 and later sells them for $4,000, incurring a $1,000 loss. Ten days after the sale, the investor repurchases 100 shares of the same company for $4,200. Because the repurchase occurred within the 30-day window, the $1,000 loss is disallowed and added to the cost of the new shares, making the adjusted cost basis $5,200 ($4,200 purchase price + $1,000 disallowed loss).

Another effect is on the holding period of the replacement securities. The holding period of the original shares sold at a loss is added to the holding period of the new shares. In the previous example, if the original shares were held for 11 months, that period is tacked onto the new shares. This may help the new shares qualify for long-term capital gains tax rates sooner.

Identifying Substantially Identical Securities

The wash sale rule hinges on the concept of “substantially identical” securities. The IRS has not provided a rigid definition, but some guidelines are clear. The most straightforward example is the common stock of the same corporation; selling and then repurchasing shares of that same company is a clear-cut case.

The rule extends beyond common stock to contracts or options to buy or sell the stock. For instance, selling a stock at a loss and then buying a call option on that same stock within the 61-day window would trigger a wash sale. Certain bonds or preferred stocks from the same issuer may be considered substantially identical if they are convertible into the common stock that was sold.

The determination of what is substantially identical depends on the specific facts and circumstances. However, some securities are not considered substantially identical. For example, the stock of two different companies in the same industry would not be viewed as identical. Bonds from the same issuer may also not be substantially identical if they have significantly different terms, such as different maturity dates or interest rates.

Special Considerations for Different Accounts

The wash sale rule’s application is not limited to a single investment account, as it extends across all of an individual’s accounts and even to accounts of related parties. For instance, if an individual sells a security at a loss in their brokerage account and their spouse repurchases the same security in their own account within the 61-day window, it is a wash sale. The same principle applies to a corporation that the individual controls.

A noteworthy situation arises with tax-advantaged retirement accounts, such as traditional or Roth IRAs. If an investor sells a security at a loss in a taxable brokerage account and then buys the same security in their IRA within the 61-day window, the loss in the taxable account is disallowed. This creates what is often called the “IRA trap.”

The issue with this scenario is that the disallowed loss cannot be added to the cost basis of the securities purchased within the IRA. The basis of assets in an IRA is not tracked for tax purposes in the same way as in a taxable account. Consequently, the tax benefit of the disallowed loss is permanently lost, as the investor cannot use it to offset future gains.

How to Report a Wash Sale on Your Tax Return

When a wash sale occurs, it must be reported on the taxpayer’s annual tax return. The primary form for this is IRS Form 8949, “Sales and Other Dispositions of Capital Assets.” The totals from this form are then carried over to Schedule D, “Capital Gains and Losses.”

To report a wash sale on Form 8949, the transaction is entered with the details of the sale. In column (f) of the form, you must enter the code “W” to indicate that the transaction was a wash sale. This code signals to the IRS that a loss is being disallowed.

In column (g) of Form 8949, the amount of the disallowed loss is entered as a positive number. This entry adjusts the total gain or loss for the transaction. By adding the disallowed loss back, the net result on the form will reflect that the loss is not being claimed for tax purposes in the current year.