NIBM - The IRS Wash Sale Rule

Tax Talk: Navigating the IRS Wash Sale Rule - Part One

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July 25, 1999 Bret A. Espey, CPA, Espey Accounting Services

"It’s not so bad…honest!"

When savvy investors start talking about investing, the subject invariably turns to gains and losses. With such talk, the subject of federal capital gains tax often rears its ugly head. Immediately we try to change the subject to something more mundane (like mountain biking or how your golf game is going) but we just can’t avoid it.

On the bright side, this stuff isn’t as scary or intimidating as you might think. Plus, you need to understand these basics. In fact, not knowing these rules can do some serious damage to your finances.

A rule that occasionally affects investors (and especially day traders and swing traders) is the Wash Sale Rule. It is simple to understand, yet there are some twists and turns that can affect the unwary. These twists will take several articles to unravel. In this article, I’d like to lay out the basics for you.

"Rub a Dub Dub….." (The Basics)

The IRS took care of this potential loophole with the Wash Sale Rules. In their simplest form, the rules state:

1. If you sell a stock at a loss, you cannot claim the loss on your federal income tax return if you purchase another lot of a substantially identical security (basically, the same stock) 30 days before or after the sale occurred.

2. The disallowed loss is added to the basis of the new stock, and

3. The holding period of the new stock will also include the holding period of the stock you sold.

Let's examine each of these issues

1. "No Loss for YOU…." (or "The Case of the Tax Nazi")

The best way to describe a disallowable loss is with an example:

Example 1: Joe Investor buys 100 shares of Microsoft for $1,000 on July 7^th, 1997. On September 5^th, 1998, he sells the shares for $750, resulting in a $250 loss on the sale. He then buys another 100 shares on the same day, September 5^th, for $750. Joe cannot claim the $250 loss on his 1998 tax return because he bought 100 shares of the same stock within 30 days of the sale.

It is important to note that the wash sale period is actually 61 days: 30 days before the sale, 30 days after the sale, plus the date of sale. Don’t miscount when trying to determine whether or not to unload a stock or you could get bitten! It’s also easy to forget that the period includes 30 days before the sale. Be careful!

2. Pay yourself now, or pay yourself later….

You don’t lose the tax advantage of the loss, just delay it a little. You get to add that loss to the basis of the new stock. That way, whenever you sell that second lot of stock (and assuming there are no wash sale consequences on that stock sale either) you will have a larger basis on which to figure the gain or loss.

Example 2: Joe gets nervous about the state of the computer industry and decides to sell his second lot of Microsoft shares from Example 1. He sells the 100 shares for $800 on November 26^th1998, and doesn’t buy any more shares for the rest of the year. His basis in the second lot of shares is his purchase price ($750) plus the disallowed loss from the first sale ($250) for a total of $1,000. His loss on the sale of the stock is $200 (the $800 sale price less his $1,000 basis). Note that if Joe was not able to add that loss to the basis, he would actually have a gain of $50 ($800 less the original purchase price of $750).

3. "Time is not on your side…"

The third part of the rule states the holding period of the new stock includes the holding period of the old stock. This prevents someone from taking advantage of the capital gain and loss rules. The netting of capital gains and losses deserves its own attention, and will be the subject of a future Tax Talk article. There are many reasons why a long-term loss (for stocks held one year or more) does less good for you than a short term loss (for stocks held less than a year), so generally this part of the rule works against you.

Example 3: Joe has also held 100 shares of Starbucks since May 23rd, 1996. He sells them on October 5^th 1998 at a loss, and buys another 100 shares of Starbucks on October 12^th 1998, triggering the wash sale rules. If Joe sells his second lot of Starbucks shares on November 26^th1998, any gain or loss would be considered a long-term gain or loss. The only reason for this is because the first lot of stock was held for more than one year, and because the wash sale rules were triggered.

Tax Planning Tips:

If you’re thinking about selling a stock, timing is obviously the key. Don’t buy the new stock within the wash sale period and you’re home free. This becomes especially critical if the timing of your loss is important. If taking a loss this year makes better sense (for example, if you think you’ll be in a higher tax bracket this year than in the future), it may make sense to buy the second lot outside of the wash sale period to ensure you can take the loss. The risk here is the stock may rise in price before you buy it back, but hey….you already know about risk, don’t you?

Watching out for the wash sale rule is especially important around end-of-year tax selling.

You may be able to counter the rule by purchasing a different stock that basically moves in the same direction as the stock you want to sell. You could sell stock A at a loss, buy stock B, and take the loss because the stocks are not the same. Beware the unusual wash sale effects of certain ETFs like Holders and iShares -- which we'll cover in a later issue.

In regards to timing, many day traders and swing traders essentially take a month off from early November to early December. They sell out of their favorite short term positions and substitute similar stocks or simply buy (short) index proxies like QQQ and SPY to make sure they don’t lose out on general market gains (losses). If the traders return to buying their favorite stocks more than a month later, any previous sales of those stocks that had a loss will NOT be subject to the wonderful wash sale rule.

Just in case you were wondering, GAINS are never subject to the wash sale rules (can you actually see the IRS giving us the opportunity to postpone gains indefinitely?). You can only have a POTENTIAL wash sale situation if you sell stock at a loss.

NEXT TIME…….Wash Sales Part 2

An extended analysis of the definition of "substantially identical securities." Read this to take full advantage of the wash sale rules!
What happens if you don’t purchase the same number of shares you sold?
You have multiple buys and sells of the same stock: which sale does the wash sale rule apply to?
There are some situations where you may lose the loss permanently!

An extended analysis of the definition of "substantially identical securities." Read this to take full advantage of the wash sale rules!
What happens if you don’t purchase the same number of shares you sold?
You have multiple buys and sells of the same stock: which sale does the wash sale rule apply to?
There are some situations where you may lose the loss permanently!

THANKS – I’m interested in your questions and comments. Perhaps there is a particular tax question you’d like to ask. Send it my way and I’ll see if we can’t incorporate that into future articles. If I get enough questions I may provide a "question and answer" forum in the future. You can contact me by

The tax advice given here is based on an interpretation of the laws at the time the article was written, and should not be construed as advice given by NIBM. The above interpretation is based upon best information and an analysis of then-current interpretations of the tax code. The strategies discussed may not apply to your particular situation. We strongly suggest speaking with a tax advisor for specific questions and before making specific trading decisions based upon the information covered in this article.