A wash sale typically occurs when an investor sells a stock and then repurchases it (or one similar to it) at the same price. Since this purchase doesn’t affect their investment portfolio, it’s considered a wash.
Whether you’re active on the stock market or thinking about investing, you’ll want to know about this IRS rule. Keep reading to learn what the wash sale rule means for your taxes and how to report the sale on your tax return.
How does it work?
To put it simply, conducting a wash sale is a way to protect your finances and investment portfolio. The wash sale rule is in place to prevent taxpayers from claiming artificial losses from the sale of securities while maintaining their position in the securities. In finance, a security is a catch-all term for stocks, bonds, mutual funds and other types of investments you can buy and sell.
The holding period for a wash sale is 61 days – 30 days prior to the sale, the day of the deal, and 30 days afterward. If you sold and then repurchased an investment within that time period, the initial loss can’t be claimed on your tax return. So, if you want to avoid violating the wash sale rule, just wait 30 days after the sale date to make the purchase.
The following situation would count as a wash sale:
- An investor notices they’re in a losing position with an investment, so they’ll sell the stock or exit a trading position
- The sale allows them to take a loss they can claim on their tax return, essentially reducing their tax liability. Learn more: Taxes 101: Understanding Capital Gains and Losses
- The investor will look to repurchase the security at an equal (or lesser) price
Why does the wash rule exist?
Wash sale rules are designed to prevent people from selling investments to claim a tax break, only to buy it again to lock in a better deal. Wash sale rules cover stocks, mutual funds, bonds, and other options sold in a taxable account.
An investor might make a wash sale for the purpose of:
- Creating a deductible loss
- Using the loss to offset shares sold for a gain
- To keep the stock in your investment portfolio
What happens if you make a wash sale?
If you trigger the wash sale rule, the IRS won’t allow you to claim that loss on your taxes. If you were expecting the wash to offset your capital gains or reduce your taxable income, you might owe taxes.