Definition
The term wash sale refers to an investor that engages in a transaction to sell a security at a loss; then acquires substantially the identical security within thirty days. Now prohibited, a wash sale was used by investors to incur a tax deductible loss without substantially changing their position in a security.
Explanation
The Internal Revenue Service (IRS) 30-day wash rule prohibits investors from recognizing a loss on their federal income tax return if that same investment was reacquired within thirty calendar days of the sale of the security. In addition to the direct repurchase of a security within thirty days, wash sale rules also apply to:
Contracts and options that allow an investor to purchase substantially identical securities.
Fully taxable trades that result in the acquisition of substantially identical securities.
Note: The IRS 30-day rule applies to transactions that occur thirty calendar days before and after the sale of a security such as a stock or bond. The total black-out period for a wash sale is sixty-one calendar days, since the rule also includes the day of the transaction.
If an investor participates in a transaction that results in a wash sale, the following rules apply:
A loss on the sale of the security is not deductible on a federal income tax return.
The loss on the sale of the original security is added to the basis of the replacement security.
The holding period for the replacement security now includes the holding period of the security that was sold.