The Wash Sale Rule Keeps Your Tax Loss Claims Clean (2024)

One of the nice things about the U.S. tax code is that if one of your investments ends up in the red, you can sell it at a loss and reduce your taxable income.

Just be careful not to repurchase the same security too soon (or one that’s substantially similar), or you could end up breaking the wash sale rule.

What Is a Wash Sale?

A wash sale, also known as wash trading, is when you sell an investment and then turn around and repurchase the asset or one similar to it, often at a similar price. This is the investing equivalent of the saying “it’s a wash” because the sale and repurchase effectively has no impact on your portfolio composition or performance.

So why bother with a wash trading in the first place? To claim a loss for tax purposes.

The Internal Revenue Service (IRS) allows single filers and married couples filing jointly to deduct up to $3,000 in realized losses from their ordinary income. Married couples filing separately can each deduct $1,500 from ordinary income.

If you have more than $3,000 in realized losses, the excess losses can be carried over into future tax years in $3,000 increments.

What Is the Wash Sale Rule?

The wash sale rule prohibits an investor from taking a tax deduction if they sell an investment at a loss and repurchase the same investment, or a substantially identical one, within 30 days before or after the sale.

Because it includes the day you sell your investment, it actually works out to a full 61 days that you (or even your spouse or a corporation you control) cannot buy an investment that is the same or similar enough in the eyes of the IRS. Otherwise, your transaction may be considered a wash sale, leaving you unable to claim any of the losses you realized.

This is intended to prohibit bad faith investors from using temporary dips in an investment’s value to secure a tax break and then turning around and repurchasing the same investment to lock in a potentially better cost basis on which all future taxes on gains will be calculated.

What Does the Wash Sale Rule Cover?

The wash sale rule covers any type of identical or substantially identical investments sold and purchased within the 61-day window by an individual, their spouse or a company they control.

“It’s hard to accidentally run afoul of the rule [with stocks],” says Leslie Sauer, certified public account (CPA). The IRS makes it clear that stock ordinarily has to be from within the same corporation to trigger the wash sale rule, according to Sauer.

In other words, you’d have to sell the stock of Company A and then rebuy the shares to have a wash sale. If you bought Company B’s stock instead, even if they’re in the same industry, you should be fine.

That said, things can get a little more complex when it comes to mutual funds and exchange-traded funds (ETFs). You can’t, for instance, sell one company’s index fund and then buy another company’s tracking the same index, or even one that contains most of the same companies.

It’s important to note that the wash sale rule extends across all of your various financial accounts, from a taxable brokerage account to your 401(k).

“You [can’t] sell the investment for a loss in one account and buy it back in another account, such as an individual retirement account (IRA),” says Jason Dall’Acqua, certified financial planner (CFP) and president of Crest Wealth Advisors. “This would disallow the loss to be used since both accounts are under your ownership.”

What Happens If You Make a Wash Sale?

If you trigger the wash sale rule, whether intentionally or unintentionally, the IRS won’t allow you to claim that loss on your taxes in current or, if it’s large enough, future years.

If you were counting on that to offset your capital gains or reduce your taxable income, you may end up owing more taxes than you expect. That can really put a damper on some people’s tax-loss harvesting strategy.

You may still see some benefit from your wash sale, though. You can add the amount of your loss to the cost of how much it was to repurchase the same or substantially identical investment. This raises your cost basis, which may save you money on your capital gains tax later—or if you sell the investment at a loss in the future, you may be able to claim a greater loss than otherwise.

3 Ways to Avoid the Wash Trading

If you’re concerned about incurring a wash sale, you can generally avoid triggering it by doing one or more of the following:

Wait 30 Days

Waiting to buy the same, or a similar, investment for the full 30-day period after you sell your investment is the surest way to avoid a wash sale. (You’ll also want to make sure you didn’t buy the same, or a similar, investment the day you sold or in the 30 days leading up to your sale.)

Some investors may go a little stir crazy, so if you can’t stand to have your money on the sidelines, make sure to put it into a substantially different investment.

Find a Materially Different Investment

While the IRS rule on what constitutes “substantially identical” is not crystal clear, the bottom line is the government doesn’t want you getting a tax break for something that’s not really a loss for you.

“Let’s say you sold an investment in the tech realm,” Sauer says, “finding another investment that is also in tech but farther out from the one you sold could be a strategy for avoiding a wash sale.” You might also consider a fund purchase that covers the same or a similar sector to the stock you sold.

To be extra careful, you can be certain that you will avoid the wash sale rule if you invest in a completely different industry or sector. If you’re not entirely sure how different your alternative investment needs to be, Sauer suggests consulting with a financial advisor or tax professional. You might also consider using a robo-advisor to do your tax-loss harvesting for you.

Have an Investment Plan

Investors unprepared for short-term market downturns may accidentally trigger the wash sale rule if they panic sell and then rebuy the same investment once the market starts recovering.

Having a long-term investment plan that you stick to, even during market downturns, can help you make the best investing and tax decisions for good times and bad.

Does the Wash Sale Rule Apply to Cryptocurrency?

Because it is not technically a stock, cryptocurrency is not susceptible to the wash sale rule, according to Dall’Acqua. This means crypto investors have the ability to sell their coins at a loss, take the tax deduction from that loss and immediately repurchase the same cryptocurrency.

Recent congressional proposals would close this loophole, however, potentially as soon as Jan. 1, 2022. These are not yet set in stone and likely would not be retroactive to 2021, so if you plan to claim losses from crypto in 2022 and beyond make sure to speak with a tax advisor first.