Wash-Sale Rule: What To Avoid When Selling Your Losing Investments | Bankrate (2024)

Portions of this article were drafted using an in-house natural language generation platform. The article was reviewed, fact-checked and edited by our editorial staff.

Investors looking to write off any capital losses need to beware of wash sales, which can derail their attempt to claim a deduction during tax time. A wash sale is one of the key pitfalls to avoid when trying to take advantage of tax-loss harvesting to reduce your taxes, and in falling markets it can be valuable to make sure you don’t run afoul of the rules.

Key takeaways

  • A wash sale occurs when an investor sells an asset for a loss but repurchases it within 30 days.
  • The wash-sale rule applies to stocks, bonds, mutual funds, ETFs, options and futures but not yet to cryptocurrency.
  • While it is not illegal to make a wash sale, it is illegal to claim a tax write-off for it, and the IRS may impose penalties for doing so.
  • Tax-loss harvesting is a popular strategy, but it's important to avoid wash sales in order to claim the write-off.

What is a wash sale?

A wash sale is when you sell an asset, such as a stock or bond, for a loss but have purchased the same asset or a very similar one within 30 days before or after the sale. A wash sale makes it appear as if you have sold your position and disowned the property, though you really haven’t.

If you’re claiming to have lost money on the sale of an asset, but it’s actually part of a wash sale, the Internal Revenue Service (IRS) disallows you from claiming a write-off on your tax return until you fully exit the position.

The wash-sale rule applies to stocks, bonds, mutual funds, ETFs, options, futures and warrants.

However, the wash-sale rule does not apply to cryptocurrency, at least not yet. So crypto traders who are looking to claim a tax deduction can literally sell their investment and immediately repurchase it and still get to take advantage of tax-loss harvesting.

How to avoid violating the wash-sale rule

Normally, the IRS allows you to write off your capital losses, and you can use losses to offset any capital gains. In fact, in any given year you can write off a net loss of up to $3,000, if you have eligible losses. That is, tax rules allow you to more than offset any gains. Savvy investors strategically use losses to minimize their taxable income through tax-loss harvesting.

If you have a wash sale, however, you cannot claim the write-off until you finally sell the asset and avoid repurchasing it for at least 30 days. After that period, you can re-buy the asset without triggering the wash-sale rules. Of course, if you lose money on this repurchase and sell it yet again, you’ll have to wait another 30 days before repurchasing the asset to avoid a wash sale.

Don’t fret that you’ll lose your tax break forever due to the wash-sale rule, however. The ability to claim your loss is only deferred, not eliminated. Simply do not re-buy the asset in the 30-day window, and you can safely claim the loss on your tax return and without any further penalty.

4 sneaky wash-sale workarounds that won’t work

Investors sometimes think they can work around the wash-sale rule through a variety of clever measures, but the IRS regularly disallows these maneuvers. Here are a few of the most popular.

1. You sell for a loss, while your spouse buys

The wash-sale rule applies to both you and a spouse as if you were a unit. For example, you may not claim a loss while your spouse re-buys the asset within the 30-day window.

This rule also applies to a corporation that you control. So you cannot have the corporation buy while you’re selling and still claim the loss as a deduction.

2. You sell for a loss but re-buy in a retirement account

You may not sell an asset for a loss in a taxable account and then re-buy the asset inside a retirement account such as a 401(k) or an IRA within the 30-day window and still claim a loss in the taxable account.

Also, it’s important to note that you cannot claim tax losses inside tax-advantaged retirement accounts, so other wash-sale rules do not apply when trading within those accounts.

3. Sell at year-end and re-buy when January starts

Tax-loss harvesting is one of the most popular tax-reduction strategies, but those doing it near the end of the year will want to pay particular attention to this rule. You’ll only have until the end of the calendar year to position your portfolio to be in compliance. So you must clear wash sales by Dec. 31 to be able to claim any associated loss on that year’s tax return.

But don’t think that once the new year begins that you can re-buy the asset within 30 days and not run afoul of the law. Your brokerage is watching, and the delay between the end of the year and when your taxes are due gives your firm plenty of time to report your account accurately.

4. You buy the asset you want to sell less than 30 days before

Some investors may think that they can reverse the order of a wash sale, buying more of the asset before they later sell less than 30 days later and declare a loss on it. But the IRS disallows this activity, since you may not buy 30 days before or after the sale and still claim a loss.

For example, imagine you have 100 shares of stock that you’ve lost money on. Knowing that you want to sell your current position for a loss, you buy another 100 shares. Then less than 30 days later you sell the original 100 shares for a loss. This transaction still counts as a wash sale.

Given their frequent trading of securities, day traders may want to pay particular attention to wash-sale rules, since they’re apt to run into the issue.

Are wash sales illegal and what are the penalties?

It’s worth noting that it’s not illegal to make a wash sale. However, it is illegal to claim a tax write-off for a wash sale. You can create as many wash sales as you want during the course of the year. But you will not be able to claim them as deductible losses for tax purposes until you finally sell your position and do not repurchase the asset for at least the 30-day window.

The IRS will disallow your loss, and you won’t be able to claim a write-off on your tax return. You’ll end up owing taxes on any income that you tried to offset with your wash sale. If you’re not current on your taxes, you can incur typical penalties for non-payment, including fines.

Tax implications of a wash sale

If you have a wash sale, you won’t be allowed to claim the loss on your taxes. Instead, what you need to do is add the loss to your cost basis in the new position. When you sell the new stake, you’ll be able to claim the loss. Let’s run through an example to see how it works.

For example, let’s say you have 100 shares of XYZ stock that you bought for $10 a share, or $1,000 total. You sell the stock for $8 a share and then 23 days later re-buy 100 shares for $7 a share. Because you’ve repurchased the stock within the 30-day window, you have a wash sale.

So you won’t be able to claim a loss on the first lot of 100 shares, and you’ll have to add the disallowed loss onto the cost basis of your new 100 shares. In this case, your initial loss of $200 is added to your new purchase of $700 ($7 * 100 shares), meaning your new cost basis is $900. Your capital gains taxes will be figured using this adjusted cost basis.

Your broker will generally (though not always) figure wash sales for you, so you usually won’t have to do it yourself. But if you’re looking to optimize your tax-loss harvesting, you may want to know exactly where you stand at the end of year so that you can claim all the losses you can.

If you accidentally (or intentionally) write off the loss on a wash sale, the IRS will re-figure your tax and bill you for the difference. Remember, the IRS has all the same figures your broker provides you. So you’ll have to cough up any difference in taxes created by the error.

Bottom line

The wash-sale rule is not hard to avoid running afoul of, but if you’re trading in and out of shares regularly, it may be easy to forget. Rather than add up your losses and gains throughout the year, it may be easiest to simply close out any position you want to claim a loss for and then not repurchase the asset for a full 30 days. Some investors may zero out their balances by the end of November, avoid these assets during December and be ready to trade again first thing in January.

Wash-Sale Rule: What To Avoid When Selling Your Losing Investments | Bankrate (2024)

FAQs

Wash-Sale Rule: What To Avoid When Selling Your Losing Investments | Bankrate? ›

Savvy investors strategically use losses to minimize their taxable income through tax-loss harvesting. If you have a wash sale, however, you cannot claim the write-off until you finally sell the asset and avoid repurchasing it for at least 30 days.

What would be a loss from the sale of an investment? ›

When a security or investment is sold for less than its original purchase price, then the dollar amount difference is considered a capital loss. For tax purposes, capital losses are only reported on items that are intended to increase in value.

Can you write off 100% of stock losses? ›

If you own a stock where the company has declared bankruptcy and the stock has become worthless, you can generally deduct the full amount of your loss on that stock — up to annual IRS limits with the ability to carry excess losses forward to future years.

How to avoid wash sale rule? ›

To avoid a wash sale, you could replace it with a different ETF (or several different ETFs) with similar but not identical assets, such as one tracking the Russell 1000 Index® (RUI). That would preserve your tax break and keep you in the market with about the same asset allocation.

What qualifies as a capital loss? ›

A capital loss is the loss incurred when a capital asset, such as an investment or real estate, decreases in value. This loss is not realized until the asset is sold for a price that is lower than the original purchase price.

When should you sell investments at a loss? ›

An investor may also continue to hold if the stock pays a healthy dividend. Generally, though, if the stock breaks a technical marker or the company is not performing well, it is better to sell at a small loss than to let the position tie up your money and potentially fall even further.

What happens when you lose investors money? ›

They write it off and move on. Unless there was some sort of fraud or something, true professional investors will be fine with it. The only real exception will be if they've written a really, really big check, often over multiple rounds.

How do you write off worthless investments? ›

Bottom line. If you have a worthless asset, you can claim your tax write-off and reduce your taxable income. But it's important that you follow the IRS procedures, because your brokerage may not report your loss on worthless securities that remain in your account if you can't dispose of them.

How to write off investment losses? ›

You must fill out IRS Form 8949 and Schedule D to deduct stock losses on your taxes. Short-term capital losses are calculated against short-term capital gains to arrive at the net short-term capital gain or loss on Part I of the form.

How to write off worthless stock? ›

Report the valueless stock in either Part I or Part II of Form 8949, depending on whether it was a short-term or long-term holding. If an asset became worthless during the tax year, it is treated as though it were sold on the last day of the year.

How do you sell stock and avoid wash sale? ›

To avoid a wash sale, the investor can wait more than 30 days from the sale to purchase an identical or substantially identical investment or invest in exchange-traded or mutual funds with similar investments to the one sold.

How much stock loss can you write off? ›

No capital gains? Your claimed capital losses will come off your taxable income, reducing your tax bill. Your maximum net capital loss in any tax year is $3,000. The IRS limits your net loss to $3,000 (for individuals and married filing jointly) or $1,500 (for married filing separately).

Is it a wash sale if I sell the entire position? ›

A wash sale is when you sell an asset, such as a stock or bond, for a loss but have purchased the same asset or a very similar one within 30 days before or after the sale. A wash sale makes it appear as if you have sold your position and disowned the property, though you really haven't.

What are examples of capital losses? ›

You have a capital loss if you sell the asset for less than your adjusted basis. Losses from the sale of personal-use property, such as your home or car, aren't tax deductible.

Do I pay taxes if I sell stocks at a loss? ›

Selling a stock for profit locks in "realized gains," which will be taxed. However, you won't be taxed anything if you sell stock at a loss. In fact, it may even help your tax situation — this is a strategy known as tax-loss harvesting.

Why are capital losses limited to $3,000? ›

The $3,000 loss limit is the amount that can be offset against ordinary income. Above $3,000 is where things can get complicated.

How is loss on sale of investment taxed? ›

If you sell an investment for less than the cost to acquire it, you make a capital loss. You can use a capital loss to: reduce capital gains made in the year the loss occurs, or. carry forward the loss to offset future capital gains.

Where does loss on sale of investments go on income statement? ›

Both gains and losses do appear on the income statement, but they are listed under a category called “other revenue and expenses” or similar heading. This category appears below the net income from operations line so it is clear that these gains and losses are non-operational results.

What is a loss on the sale of an asset? ›

Definition of Gain or Loss on Sale of an Asset

If the cash received is greater than the asset's book value, the difference is recorded as a gain. If the cash received is less than the asset's book value, the difference is recorded as a loss.

How is the sale of an investment asset for a loss recorded? ›

Credit the asset

Selling it for more than its depreciated value shows you gained cash for your asset, and selling the asset for less than its depreciated value shows the loss you took on the asset. Record losses as debit and gains as credit in your entry.

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