What Is the Wash Sale Rule and Why Does It Matter?
The Wash Sale Rule is a tax regulation enforced by the IRS that prevents investors from claiming a tax deduction on capital losses if they repurchase the same or a substantially identical stock within 30 days before or after selling it at a loss. The rule exists to prevent investors from engaging in “tax-loss harvesting” without actually altering their investment position.
For example, if you sell shares of Apple (AAPL) at a loss and then repurchase them within this 61-day window (30 days before the sale + the sale date + 30 days after), the IRS will disallow your capital loss deduction on that transaction. Instead, the loss will be added to the cost basis of the repurchased stock, deferring the deduction until a later sale.
This rule is crucial for both new and experienced investors because violating it can lead to unexpected tax consequences. Whether you’re a long-term buy-and-hold investor or someone who occasionally rebalances your portfolio, understanding the wash sale rule helps you legally reduce your tax bill and avoid IRS penalties.
For more details on IRS tax regulations regarding investments, you can refer to IRS Publication 550
What This Article Covers:
- How the Wash Sale Rule works and what triggers it
- Common mistakes investors make
- Legal strategies to avoid wash sale violations
- How the rule applies to ETFs, mutual funds, and retirement accounts
- Smart tax-loss harvesting strategies that comply with IRS regulations
For a deeper understanding of tax-efficient investing, check out The Ultimate Tax Guide for Long-Term Investors.
How the Wash Sale Rule Works
1. Understanding the 61-Day Window
The wash sale rule applies if you:
✅ Sell a stock at a loss
✅ Repurchase the same or a substantially identical security
✅ Do this within 30 days before or after the sale date (a total 61-day window)
If you violate this rule, the IRS disallows your loss for tax purposes and instead adds the loss amount to the cost basis of the new shares. This means the tax benefit is postponed until you eventually sell the new shares.
2. What Qualifies as a “Substantially Identical” Security?
The IRS does not clearly define “substantially identical”, but in general:
- Buying the exact same stock (e.g., selling Tesla (TSLA) and buying Tesla (TSLA) again) definitely triggers the rule.
- Buying an option or convertible bond tied to the same stock also triggers the rule.
- Swapping one S&P 500 index fund for another might be considered substantially identical, but swapping a tech ETF for a financial ETF is not.
For a more in-depth breakdown, Investopedia provides a helpful guide on the Wash Sale Rule.
3. How This Affects Buy-and-Hold Investors
Even if you’re a long-term investor, the wash sale rule can impact you when:
- Rebalancing your portfolio and repurchasing the same stock too soon.
- Harvesting tax losses but unknowingly violating the 61-day rule.
- Using dividend reinvestment plans (DRIPs) that automatically buy shares within the restricted period.
Pro Tip: If you reinvest dividends automatically, check whether small purchases could trigger a wash sale when selling shares at a loss.
Common Mistakes Investors Make
1. Selling and Buying Too Quickly
One of the most common mistakes is selling a stock at a loss and repurchasing it too soon, thinking the tax loss is still valid.
✅ Example: You sell Microsoft (MSFT) for a $500 loss on January 10.
❌ If you repurchase MSFT on January 25, the loss is disallowed under the wash sale rule.
✅ To claim the loss, you must wait until at least February 11 before repurchasing.
2. Buying the Same Stock in a Different Account
Many investors assume the wash sale rule only applies to one account, but the IRS enforces the rule across all accounts under your control, including:
- Taxable brokerage accounts
- IRAs and Roth IRAs
- Spouse’s accounts (if filing jointly)
✅ Example: Selling shares of Amazon (AMZN) in your taxable brokerage account and repurchasing them in your Roth IRA still triggers the wash sale rule.
3. Buying a Nearly Identical ETF or Mutual Fund
The IRS may consider swapping one S&P 500 ETF for another to be “substantially identical.”
✅ Example: Selling Vanguard’s S&P 500 ETF (VOO) and buying iShares’ S&P 500 ETF (IVV) could trigger a wash sale.
✅ A better strategy would be swapping into a similar, but not identical, ETF (e.g., a total stock market ETF instead of an S&P 500 ETF).
For a full guide on tax-efficient investing, Fidelity has a useful guide on the Wash Sale Rule and Tax-Loss Harvesting.
To learn about different investing strategies, check out Finding the Right Investment Style.
How to Legally Avoid the Wash Sale Rule
✅ 1. Wait 31 Days Before Rebuying
The simplest way to avoid a wash sale is to wait at least 31 days before buying the same stock again.
✅ 2. Buy a Similar but Not Identical Investment
Instead of repurchasing the same stock, consider investing in a similar company in the same sector.
✅ Example: Instead of rebuying Nvidia (NVDA), you could buy AMD (AMD).
✅ 3. Use a Tax-Advantaged Account for Reinvesting
If you plan to repurchase quickly, consider using a Roth IRA or Traditional IRA since losses aren’t deductible in tax-sheltered accounts anyway.
For more smart investment planning tips, read Why You Should Consider Creating a Personal Investment Checklist.
FAQs About the Wash Sale Rule
❓ Does the Wash Sale Rule Apply to Crypto?
No. As of 2024, cryptocurrencies are not subject to the wash sale rule, though legislation may change in the future.
❓ Does It Apply to Short Sales?
Yes. If you short-sell a stock and buy back the same stock within 30 days, the wash sale rule applies.
❓ Do Wash Sales Affect My Taxes in Future Years?
Yes. If your loss is disallowed, it carries over by increasing the cost basis of the repurchased stock, reducing future taxable gains.
For more investing fundamentals, read Getting Started with a Buy-and-Hold Strategy.
Final Thoughts on the Wash Sale Rule: Stay Tax-Smart & Invest Wisely
Understanding the wash sale rule is essential for any investor who wants to maximize tax efficiency while avoiding IRS penalties. The key takeaways are:
✅ The wash sale rule disallows tax losses if you repurchase a stock within 30 days before or after selling at a loss.
✅ It applies across all of your accounts, including IRAs.
✅ You can avoid it by waiting 31 days, buying a similar but not identical investment, or using a tax-advantaged account.
For more guidance on smart investing, check out 10 Common Mistakes Beginner Investors Make (And How to Avoid Them).
Happy Investing!