What it means
Selling a losing investment and claiming the loss against gains is legitimate tax planning, usually called tax loss harvesting. The problem is that an investor could sell on Monday, claim the loss, and buy the identical holding back on Tuesday, ending up with the same portfolio and a tax deduction they did not really earn.
The wash sale rule blocks that by disallowing the loss if the investor buys a substantially identical security within 30 days before or after the sale, a 61 day window in total. The disallowed loss is added to the cost base of the new holding, so the tax benefit is deferred rather than destroyed.
The phrase "substantially identical" is the part that causes the most argument. Buying back the same company's shares clearly counts, while switching from one broad index fund to a different provider's index fund tracking a different index is usually accepted, and the ground in between is genuinely grey.
The rule also reaches across accounts, which surprises many investors. Selling a holding in a taxable brokerage account and buying it back inside a retirement account within the window still triggers the rule, and in that case the disallowed loss can be permanently forfeited rather than deferred.
Other countries have equivalent provisions under different names, such as the bed and breakfasting rules in the UK, so the concept travels even though the exact windows differ. For business owners, the same logic applies to any deliberate sale designed to crystallise a loss without changing economic exposure.
In practice
Real-world examples.
Example
An investor sells a technology holding on 20 December to book a $30,000 loss against gains made earlier in the year, then buys it back on 5 January because he still likes the company. The repurchase falls 16 days after the sale, the loss is disallowed for that tax year, and his tax bill is higher than he planned.
Example
A financial adviser wants to keep a client invested in the broad market while harvesting a loss. She sells one large-cap index fund and immediately buys a different provider's fund tracking a different large-cap index, keeping market exposure while staying outside the substantially identical test.
Example
An investor sells shares at a loss in her taxable account and, unaware of the cross-account rule, her automatic monthly contribution buys the same fund inside her retirement account eight days later. The loss is disallowed and, because the replacement sits in a tax-sheltered account, she cannot recover it later.
Think of it
“Wash sale rule prevents fake loss harvesting-you can't immediately rebuy the same thing.
Formula
Calculation
Adjusted cost base of replacement holding = purchase price of replacement + disallowed loss
An investor buys 1,000 shares at $50, a total cost of $50,000. The price falls and she sells all 1,000 shares at $38, receiving $38,000 and creating a loss of $50,000 - $38,000 = $12,000.
Ten days later she buys 1,000 shares of the same company back at $39, a cost of $39,000. Because the repurchase falls inside the 30 day window, the $12,000 loss is disallowed and instead added to her cost base: $39,000 + $12,000 = $51,000.
If she later sells those shares at $60, receiving $60,000, her taxable gain is $60,000 - $51,000 = $9,000 rather than the $21,000 it would otherwise have been. The $12,000 has not disappeared; it has simply been deferred into the later sale.Case study
Seen in the real world.
The following is an illustrative and fictional example. Harborline Advisers, an invented boutique wealth firm, ran an automated tax loss harvesting service for around 300 clients and marketed the expected tax saving as a headline benefit. Its software sold losing positions and bought replacements the same day, checking only the taxable account it was trading in.
At the end of the first year, an accountant reviewing one client's paperwork noticed that the client's separate retirement account, held elsewhere and outside Harborline's view, had bought the same fund inside the window on several occasions. A wider review found similar overlaps affecting roughly one client in six, and about $180,000 of claimed losses across the book had to be reversed.
The fictional firm rebuilt its process to require clients to disclose all accounts, added a 31 day quarantine list per household rather than per account, and switched replacements to funds tracking clearly different indices. Its harvested losses fell by about a fifth, but the ones it did claim survived review.
Watch out
Common mistakes.
- Counting only the 30 days after the sale, when the rule also covers the 30 days before it, making a 61 day window in total.
- Ignoring automatic reinvestment of dividends, which counts as a purchase and can trigger the rule on a tiny transaction.
- Assuming the rule stops at the boundary of one account, when purchases in a spouse's account or a retirement account can also catch it.
Questions
People also ask.
Does a wash sale mean the loss is gone forever?
Usually not; it is added to the cost of the replacement holding and reduces the taxable gain when that is eventually sold.
Does the rule apply to gains as well as losses?
No, it applies only to losses; selling at a gain and buying straight back simply crystallises the gain and the tax on it.
Is switching between two different companies in the same sector a wash sale?
Generally no, because shares in two different issuers are not substantially identical, though selling and rebuying the same company's shares clearly is.
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