To add:
Wash Sales 101
How the wash sale rule works.
When the value of your stock goes down you get that sinking feeling — you've lost money. But the tax law doesn't allow that loss until you sell the stock. In a way that's good, because it means you can control the timing of your deduction, taking it when the benefit is the greatest.
The problem is, you may have a conflict. You want to deduct the loss, but you also want to keep the stock because you think it's going to bounce back. It's tempting to think you can sell the stock and claim the loss, then buy it back right away. And that's where the wash sale rule comes in. If you buy replacement stock shortly after the sale — or shortly before the sale — you can't deduct your loss.
General Rule
In general you have a wash sale if you sell stock at a loss, and buy substantially identical securities within 30 days before or after the sale.
Example: On March 31 you sell 100 shares of XYZ at a loss. On April 10 you buy 100 shares of XYZ. The sale on March 31 is a wash sale.
The wash sale period for any sale at a loss consists of 61 days: the day of the sale, the 30 days before the sale and the 30 days after the sale. (These are calendar days, not trading days. Count carefully!) If you want to claim your loss as a deduction, you need to avoid purchasing the same stock during the wash sale period. For a sale on March 31, the wash sale period includes all of March and April.
Contracts and Options
The wash sale rule can apply even if you don't acquire stock. If you enter into a contract or option to acquire stock, that's enough to make the wash sale rule apply. Your sale of stock can also be a wash sale if, within the wash sale period, you sell a put option on the same stock that's "deep in the money." And you can have a wash sale from selling options at a loss, too. For more on this subject see Wash Sales and Options.
Consequences of a Wash Sale
The wash sale rule actually has three consequences:
You are not allowed to claim the loss on your sale.
Your disallowed loss is added to the basis of the replacement stock.
Your holding period for the replacement stock includes the holding period of the stock you sold.
The first one is clear enough, but the others may require some explanation.
Basis Adjustment
The basis adjustment is important: it preserves the benefit of the disallowed loss. You'll receive that benefit on a future sale of the replacement stock.
Example: Some time ago you bought 80 shares of XYZ at $50. The stock has declined to $30, and you sell it to take the loss deduction. But then you see some good news on XYZ and buy it back for $32, less than 31 days after the sale.
You can't deduct your loss of $20 per share. But you add $20 per share to the basis of your replacement shares. Those shares have a basis of $52 per share: the $32 you paid, plus the $20 wash sale adjustment. In other words, you're treated as if you bought the shares for $52. If you end up selling them for $55, you'll only report $3 per share of gain. And if you sell them for $32 (the same price you paid to buy them), you'll report a loss of $20 per share.
Because of this basis adjustment, a wash sale usually isn't a disaster. In most cases, it simply means you'll get the same tax benefit at a later time. If you receive the benefit later in the same year, the wash sale may have no effect at all on your taxes.
There are times, though, when the wash sale rule can have truly painful consequences.
If you don't sell the replacement stock in the same year, your loss will be postponed, possibly to a year when the deduction is of far less value.
If you die before selling the replacement stock, neither you nor your heirs will benefit from the basis adjustment.
You can also lose the benefit of the deduction permanently if you sell stock and arrange to have a related person — or your IRA — buy replacement stock. See Sales to Related Persons.
As explained in our book, Consider Your Options, a wash sale involving shares of stock acquired through an incentive stock option can be a planning disaster.
Holding Period
When you make a wash sale, your holding period for the replacement stock includes the period you held the stock you sold. This rule prevents you from converting a long-term loss into a short-term loss.
Example: You've held shares of XYZ for years and it's been a dog. You sell it at a loss but then buy it back within the wash sale period. When you sell the replacement stock, your gain or loss will be long-term — no matter how soon you sell it.
In many situations you get more tax savings from a short-term loss than a long-term loss, so this rule generally works against you.
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