What is the wash-sale rule?
The wash-sale rule is an IRS rule that prevents investors from claiming a capital loss on the sale of a security if they repurchase the same or a substantially identical security within 30 days before or after the sale.
Why does the wash-sale rule exist?
The wash-sale rule is in place to prevent investors from artificially claiming capital losses to reduce their taxable income. For example, if an investor sold a stock for a loss and then repurchased the same stock the next day, they could effectively lock in the loss for tax purposes while still retaining their investment in the stock.he wash-sale rule is an IRS rule that prevents investors from claiming a capital loss on the sale of a security if they repurchase the same or a substantially identical security within 30 days before or after the sale.
What is a substantially identical security?
A substantially identical security is one that is so similar to the security that was sold that the investor has not materially changed their economic position. For example, two common stocks in the same industry with similar risk profiles would generally be considered substantially identical securities.
How does the wash-sale rule work?
If an investor sells a security for a loss and then repurchases the same or a substantially identical security within 30 days before or after the sale, the wash-sale rule will apply. This means that the investor cannot claim the loss on the sale for tax purposes. However, the amount of the loss is added to the cost basis of the new security. This means that the investor's taxable gain on the sale of the new security will be reduced by the amount of the wash-sale loss.
On January 1, 2023, an investor buys 100 shares of XYZ stock for $10 per share. On March 1, 2023, the investor sells the 100 shares of XYZ stock for $5 per share, realizing a capital loss of $500. On March 10, 2023, the investor buys 100 shares of XYZ stock for $6 per share.
Because the investor repurchased XYZ stock within 30 days of selling it at a loss, the wash-sale rule applies. The investor cannot claim the $500 loss on the sale of the XYZ stock for tax purposes. However, the $500 loss is added to the cost basis of the new 100 shares of XYZ stock. This means that the investor's taxable gain on the sale of the new 100 shares of XYZ stock will be reduced by $500.
How to avoid wash sales
The easiest way to avoid wash sales is to wait at least 31 days before repurchasing the same or a substantially identical security after selling it for a loss. If you need to repurchase the security sooner, you may want to consider purchasing a different security that is not substantially identical.
The wash-sale rule applies to all types of securities, including stocks, bonds, and mutual funds. It also applies to short sales.
If you have any questions about the wash-sale rule, you should consult with a tax advisor.
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