Wash Sale Rule

An IRS rule that disallows a tax loss on a security sale if you buy a 'substantially identical' security within 30 days before or after the sale — preventing investors from manufacturing paper losses while maintaining their market position.

The wash sale rule (IRC Section 1091) prevents investors from claiming a tax loss on an investment while maintaining essentially the same market exposure. The rule is triggered when you sell a security at a loss and, within a 61-day window (30 days before the sale, the day of the sale, and 30 days after), you buy a 'substantially identical' security. When a wash sale occurs, the loss is disallowed for that tax year — you can't deduct it on your return. Instead, the disallowed loss is added to the cost basis of the replacement shares, which preserves the tax benefit for the future when you eventually sell those shares without triggering another wash sale.

The rule exists to prevent a strategy that would otherwise be risk-free tax arbitrage: sell a stock that has declined in value on December 31 to generate a tax loss, then immediately buy it back on January 2, effectively claiming a deduction without ever actually changing your investment position. Congress designed the wash sale rule to require that you actually bear economic risk during the exclusion window — if you want the tax loss, you have to genuinely exit the position (or accept the 30-day gap).

'Substantially identical' is a key — and sometimes ambiguous — term. Selling Apple shares and buying Apple shares back within 30 days is clearly a wash sale. Selling Apple and buying Microsoft is clearly not. The gray area involves selling a security and buying into an ETF or mutual fund that holds it substantially. The IRS has not issued clear guidance on whether ETF substitutions trigger wash sales — the general practitioner consensus is that moving from one ETF to a different ETF with similar but distinct composition (e.g., selling VOO and buying SCHB) is not a wash sale, but that buying back the identical fund would be. Consult a tax advisor for securities with substantial overlap.

The wash sale rule applies across all your accounts at all brokers — it's not per-account. If you sell a stock at a loss in your taxable brokerage account and your spouse buys the same stock in their IRA within the 30-day window, that's a wash sale. If you sell in your taxable account and buy in your IRA directly, that's also a wash sale — and the loss is permanently disallowed (not just deferred), because IRAs don't have a basis that can absorb the added cost. This cross-account and cross-spouse application catches many investors by surprise.

How Wash Sales Work in Practice

  • You buy 100 shares of XYZ at $50 (cost basis: $5,000).
  • XYZ drops to $35. You sell all 100 shares for $3,500 — a $1,500 loss.
  • Within 30 days, you buy 100 shares of XYZ again at $36.
  • The $1,500 loss is disallowed (wash sale). Instead, it's added to the new shares' basis: new basis = $3,600 (purchase price) + $1,500 (disallowed loss) = $5,100.
  • When you eventually sell those new shares (outside the wash sale window), the higher basis means your taxable gain will be $1,500 smaller — the loss is preserved, just deferred.
  • Net effect: you don't lose the tax benefit permanently; you just can't claim it yet.

Wash Sales and RSUs / Employee Stock

Wash sales are particularly relevant for employees who hold company stock through RSU vesting and also hold shares from prior vests. If you sell RSU shares at a loss and then vest into new RSU shares (or exercise options into company stock) within the 30-day window, you may have triggered a wash sale — even though the acquisition was involuntary (the vest happened on a schedule you didn't control). Most payroll systems don't flag this, and many brokers don't track it across accounts. Employees with large, regular RSU vests should be aware that tax-loss harvesting company stock is complicated by the ongoing automatic acquisition of new company shares through vesting.

Avoiding Wash Sales While Maintaining Market Exposure

  • Wait 31 days: the simplest approach — sell the losing position, wait out the 30-day window, then repurchase. You bear market risk during the gap.
  • Buy a similar but not substantially identical security: sell VOO (S&P 500 ETF) and buy SCHB (total US market ETF) — different enough to avoid wash sale treatment, similar enough to maintain broad equity exposure.
  • Double up then sell: buy more of the declining security, wait 31 days, then sell the original lot at a loss. This maintains your position continuously but requires additional capital and doubles your exposure temporarily.
  • Track everything: your broker may not catch wash sales across all accounts — keep your own records, especially if you hold the same securities at multiple institutions or in both taxable and tax-advantaged accounts.

Example

An engineer holds 200 shares of her company's stock from RSU vests, with a cost basis of $80/share. In November, the stock drops to $55 and she sells 100 shares to realize a $2,500 loss for tax purposes. In December, 50 more RSU shares vest at $57/share — a substantially identical security acquired within 30 days. A wash sale has been triggered on 50 of the 100 shares she sold. The $1,250 disallowed loss is added to the basis of the newly vested shares. She was unaware this could happen because the vest was automatic, not a purchase she initiated. Her broker's 1099 reflects the adjustment, but she missed it and initially filed incorrectly.