What Is the Wash-Sale Rule?

Define the Wash-Sale Rule In Simple Terms

A wash-sale is a tax strategy to sell and immediately repurchase stocks that have dropped in value in order to maintain ownership of the stock, but also claim a tax deduction for the loss on tax filings.

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Unrealized vs Realized Capital Loss

To understand wash-sales, one must first understand the difference between unrealized and realized capital loss.

Unrealized capital losses are “floating”losses on stocks that have not been sold, so the loss has not actually been incurred.

Losses are “realized,”or permanently incurred, when the stock is sold. Only realized capital losses are tax deductible—this is where the wash-sale rule comes into play.

To reduce tax liability, some investors may attempt to sell the stock of an unrealized loss in order to incur a realized loss, but then immediately buy the stock back to maintain their ownership in the company. This is called a “wash-sale.”

To prevent these kinds of tax-deductions, the IRS instituted the Wash-Sale Rule.

The Rule

The Wash-Sale Rule prohibits claiming losses on tax filings if the same or “substantially identical”investment is purchased within 30 days before or after the sale.

To avoid the Wash-Sale Rule, investors can either:

  • Wait until the 30-day period has passed, which runs the risk of missing out on a stock’s appreciation during that period,
  • Or utilize tax loss harvesting which sells one stock to offset the gains of another stock and invest in a similar, but not “substantially identical,”investment. These could be industry focused ETFs, mutual funds or competitors

Because profits earned from investments held for more than 1 year are categorized as long-term capital gains and are taxed at a lower tax rate than short-term capital gain, it’s important to note that selling and rebuying a stock resets the purchase date and may increase tax liability.

Wash-Sale Rule Definition FAQs

A wash-sale is a tax strategy to sell and immediately repurchase stocks that have dropped in value in order to maintain ownership of the stock but also claim a tax deduction for the loss on tax filings.
To understand wash-sales, one must first understand the difference between unrealized and realized capital loss.
The Wash-Sale Rule prohibits claiming losses on tax filings if the same or “substantially identical” investment is purchased within 30 days before or after the sale.
The IRS implemented the Wash-Sale Rule to prohibit investors from using a loss on investments that actually earn them a profit.
To not run afoul of a wash-sale scenario, an investor can wait until the 30-day period has passed, which runs the risk of missing out on a stock’s appreciation or utilize tax loss harvesting which sells one stock to offset the gains of another stock and invest in a similar, but not “substantially identical,” investment. These could be industry focused ETFs, mutual funds or competitors.
True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, his interview on CBS, or check out his speaker profile on the CFA Institute website.