Wash Sale Rule

Wash Sale Rule Explained

6 min read

What is the wash sale rule? This process happens when you sell a security or stock at a loss and buy it back within 30 days. The IRS implements this regulation, meaning you won’t get a tax deduction for your losses.

The wash sale rule is a regulation implemented by the IRS. It doesn’t allow you to get a tax deduction on a loss that falls under the rule. It occurs when an individual sells or trades a security at a loss and, within 30 days before or after this sale, buys a “substantially identical” stock or security or acquires a contract or option to do so.

Different styles of trading allow you to make a profit or loss.

One of the stock trading basics is the tug of war between buyers and sellers. As a result, there are winning and losing trades. Even the best traders fail 30-40% of the time. The wash sale rule was designed to keep you from claiming all losses of the same stock when purchased in a certain time frame.

In other words, you sell a stock for a loss and less. Then, 30 days later, you buy the identical stock, hoping to cover the loss. The IRS doesn’t want taxpayers to be able to claim artificial losses.

The opposite is true as well. Suppose you profit from a stock and buy the same stock again shortly after for another profit. It’s still taxable income.

Wash Sale Rule

Options

Options trading falls under the wash sale rule as well. You can’t claim the loss if you purchase options contracts, sell for a loss, and repurchase within 30 days.

The wash sale rule lasts a total of 60 days total. Thirty days before and 30 days after the time of a sale for stocks or options.

To break it down even further, let’s say you took a large position in a stock. It went in the opposite direction you wanted it to, so you sold it for a pretty big loss. Then, 26 days later, you bought a much smaller position of the same stock.

As a result of the wash sale rule, the first big loss you took is now null and void for taxes. Instead, any loss accrued on the smaller position will be what you can deduct.

In other words, the initial loss doesn’t count because you re-upped your position within 30 days.

How Do I Avoid a Wash Sale?

  • Here’s how you can avoid a wash sale:
  • Wait 31 days to sell shares that have a loss.
  • Purchase ETFs in the same sector.
  • Purchase mutual funds in the same sector.
  • Just avoid stocks in the same sector.

You may have a stock or sector that you enjoy trading. As a result, if you’re worried about a wash sale, you may be looking for a way to get around the rule.

For example, let’s say you sold an energy stock for a loss but another energy stock with a nice bullish pattern. Since it’s still in the same sector, the IRS will view it as an identical stock and apply it to the rule.

However, purchasing ETFs or mutual funds is a simple way to still be in the sector without getting caught in the wash sale rule. This allows you to stay in a running sector without making what the IRS would view as duplicate trades.

You can then sell your ETF or mutual fund once the period ends and return to a position with stocks or options. That doesn’t mean you can’t re-up a position, however.

You can still buy the same stock within 30 years. Just be aware that tax deductions for the first trade won’t be realized.

COURSE
Day Trading Course Options Trading Course Futures Trading Course
DESCRIPTION Learn how to read penny stock charts, premarket preparation, target buy and sell zones, scan for stocks to trade, and get ready for live day trading action
Learn how to buy and sell options, assignment options, implement vertical spreads, and the most popular strategies, and prepare for live options trading How to read futures charts, margin requirements, learn the COT report, indicators, and the most popular trading strategies, and prepare for live futures trading
INCLUDED

What Does This Mean for Day Trading?

Day trading involves getting in and out of a stock on the same day. Sometimes, even multiple times a day. Should the wash sale rule affect how you trade?

It can have implications on trading. Sometimes, traders are prohibited from buying certain stocks if they’re trading them too often. This is because of liquidity concerns (find out when to use a stock loss vs stop limit). Buying and selling the same stock, especially to recoup losses, makes it seem to have more liquidity than it does. The volume goes up, making people think it’s liquid. When in reality, it’s one person.

That can be detrimental to other traders. Hence, the suspension of a trader who does that. However, that doesn’t mean you can’t buy and sell the same stock more than once.

The goal of trading is to make profits. So, if you read patterns correctly, you can get in, sell for a profit, and get back in again on a dip. In essence, the wash sale rule applies to losses. However, there are still taxes on profits as well.

Stock trading isn’t always easy with different rules and regulations. You can always subscribe to a trading service like the Bullish Bears that posts stock watch lists each night with different stocks to keep an eye on.

Final Thoughts: Wash Sale Rule

The wash sale rule shouldn’t affect how you trade. Be aware that it could affect your taxes when claiming losses. The goal is to place winning trades. While not every trade will be a winner, keep your losses small and move on to the next trade.

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