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What is Wash Sale Rule?
In stock trading a Wash Sale occurs when you sell a security at a loss, and then purchase the same or substantially similar security within 30 days before or after the trade. Wash Sale Rule was set up to hold back investors from claiming capital losses as tax deductions, if they reenter the same or similar position in short period of time. All sales that violate this rule are subject to being considered a Wash Sale.
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In condensed manner, if an investor wants to sell a stock at a loss, and buy the same or a substantially same security within 30 calendar days before or after the trade, he or she can't deduct loss from his or her tax. Tax-loss selling is an investment strategy that aims to reduce investor's taxable income for a given tax year.
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When you sell an investment that generated loss in a taxable account, you are eligible for tax benefit. However if you do have a Wash Sale, the IRS will not allow you to deduct the investment loss which will cause your taxes for the given year be higher than expected. The Wash Sale Rule prevents investors from selling at a loss, then buying the same or substantially identical stocks back within a 61-day time-window, and claiming the tax benefit. Because rules are not straightforward for anyone we recommend you to consult with your tax advisor pertaining to your personal situation.
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If you live and pay your tax outside US, Wash Sale Rule might differ. There is still one opportunity to avoid the impact of Wash Sale Rule on an individual stock, while still sustaining your exposure to the industry or sector of the stock on which you lost money. Without violating the Wash Sale Rule you can buy a mutual fund or an exchange-traded fund (ETF) that targets the same industry. ETFs can provide a savvy way to recoup your exposure to the industry or sector of a stock you sold, as they typically hold enough stocks to meet the criteria of 'being not substantially identical' to any individual stock.
Be vigilant, you can still encounter exceptions, because there are no clear directions on what constitutes a 'substantially identical security'. The IRS determines if your trade violates the wash-sale rule. If they found reason to confirm the violation, you will end up paying more taxes than you hoped.
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If the IRS determines that your transaction was a Wash Sale, simply you are not permitted to use the loss on the sale to offset gains or reduce taxable income, but your loss is added to the cost basis of the new investment. The holding period of the stock you sold is also added to the holding period of the newly bought stock. Over time there may be an increase to a higher cost basis, and you may be able to realize a bigger loss when you sell the newly bought stock, or if stock's price rises and you sell it, you may be subject to paying less on your proceeds. The longer holding period may help you being entitled for the long-term capital gains tax rate rather than the higher short-term rate.
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WASH SALE RULE
AVOID WASH SALE
