What is the wash sale rule? This process happens when you sell a security or stock at a loss and then buy it back within 30 days. This regulation is implemented by the IRS and means that you won’t get a tax deduction for your losses.
What Is a Wash Sale Rule?
- 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.
There are different styles of trading that 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 as a way 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 same stock, or an identical one, hoping to cover the loss. The IRS doesn’t want taxpayers to be able to claim artificial losses.
The opposite is true as well. If you make a profit on a stock and buy the same stock again shortly after for another profit. It’s still taxable income.
Options trading falls under the wash sale rule as well. If you purchase options contracts then sell for a loss and repurchase again within 30 days, you can’t claim the loss.
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 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 a 30 day time frame.
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 ETF’s 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 there’s another energy stock that’s got 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, a simple way to still be in the sector without getting caught in the wash sale rule, is to purchase ETF’s or mutual funds in the sector. This gives you the ability to stay in a sector that’s running without making what the IRS would view as duplicate trades.
You can then sell your ETF or mutual fund once the time period is up and get back into 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 a 30 time period. Just be aware that any tax deductions for the first trade won’t be realized.
What Does This Mean for Day Trading?
Day trading is the practice of getting in and out of a stock 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. The reason for this is liquidity concerns (find out when to use a stock loss vs stop limit). Buying and selling the same stock, especially to recoup losses, makes a stock seem like it has 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 suspending 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. Although, there are still taxes on profits as well.
Stock market 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.
Don’t Let the Wash Sale Rule Affect How You Trade
The wash sale rule shouldn’t affect how you trade. Be aware that it could affect your taxes when it comes to 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.