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Home > Resources > About Wash Sales


What is a Wash Sale?
Understanding the IRS Wash Sale Rule, Section 1091

All About Wash Sales
Wash Sale Definitions

A simple definition of a wash sale: If you hold a loss position, dispose of it and you re-establish the same (or sufficiently similar/substantially identical) position, then you have a wash sale and cannot recognize that loss for tax purposes. For example, if you sell a stock for a loss, and immediately buy it back, then those trades have triggered the wash sale rule and you must disallow that loss.

A more comprehensive definition of a wash sale: A wash sale is the disposition of a loss position coupled with a replacement position. The replacement can occur via four different mechanisms:

  1. the replacement is the same security as was in the loss position
  2. the replacement is a contract or option to acquire the security that was present in the loss position
  3. the replacement is substantially identical to the security in the loss position
  4. the replacement is a contract or option to acquire a substantially identical security to the security that was present in the loss position

Timing and the Wash Sale Rule: The replacement must occur within a 61-day window that includes the disposition date as well as 30 days on either side of that date. The amount of loss disallowed by the wash sale cannot be recognized at the time of the wash sale, but it can be recognized in the year in which the replacement position is disposed of. This re-allowance is attained by a cost basis adjustment to the replacement position. A wash sale also affects the holding period of the replacement position.

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Examples of Wash Sales
Example 1 — Simple Wash Sale

Activity:
  • 01/03/2011 Buy 1 share of ABC at $125.
  • 01/31/2011 Sell 1 share of ABC at $100.
  • 01/31/2011 Buy 1 share of ABC at $105.
Simple Wash Sale
Event Date Investment Quantity Event Type Total Amount
01/03/2011 ABC 1.00 Buy 125
01/31/2011 ABC -1.00 Sell -100
01/31/2011 ABC 1.00 Buy 105

Result:
  • January 31st is obviously within the 61-day window that surrounds January 31st (the disposal).
  • Therefore, the taxpayer may not deduct the $25 in loss realized on January 31st.
  • Instead, that loss adjusts the cost basis of the long share to $130 ($105 original cost plus $25 disallowed loss) with a tax date adjustment that sets the acquisition date to January 3rd.

Example 2 — Short Wash Sale

Activity:
  • 01/03/2011 Short 1 share of ABC at $100.
  • 01/31/2011 To cover the short, buy 1 share of ABC at $125, which settles on 02/03/2011.
  • 03/02/2011 Short 1 share of ABC at $105.
Short Wash Sale
Event Date Investment Quantity Event Type Total Amount
01/03/2011 ABC -1.00 Short -100
01/31/2011 ABC 1.00 Buy 125
03/02/2011 ABC -1.00 Short -105
Result:

For a short transaction, the settlement date, instead of the trade date, is used for the center of the 61-day window.

  • March 2nd is within the 61-day window from February 3rd.
  • Therefore, the taxpayer may not deduct the $25 in loss realized on January 31st.
  • Instead, that loss adjusts the cost basis of the short share to $80 ($105 original cost adjusted by the $25 disallowed loss) with an appropriate adjustment to the holding period of the replacement share.
Example 3 — Call Option Wash Sale

Activity:
  • 01/03/2011 Buy 100 shares of ABC at $125.
  • 01/31/2011 Sell 100 shares of ABC at $100.
  • 03/01/2011 Buy a call option to acquire 100 shares of ABC for a total cost of $100.
Call Option Wash Sale
Event Date Investment Quantity Event Type Total Amount
01/03/2011 ABC 100 Buy 12,500
01/31/2011 ABC -100 Sell -10,000
03/01/2011 Call Option for ABC 1 Buy 100

Result:
  • The call option is a replacement.
  • The $2,500 loss realized on January 31st is disallowed.
  • Instead, the cost basis of the call is adjusted from $100 to $2,600.
  • Note the strike price of the option is irrelevant.
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The Tax Code on Wash Sales

Section 1091(a) provides that “in the case of any loss claimed to have been sustained from any sale or other disposition of shares of stock or securities where it appears that, within a period beginning 30 days before the date of such sale or disposition and ending 30 days after such date, the taxpayer has acquired (by purchase or by an exchange on which the entire amount of gain or loss was recognized by law), or has entered into a contract or option so to acquire, substantially identical stock or securities, then no deduction shall be allowed under § 165 unless the taxpayer is a dealer in stock or securities and the loss is sustained in a transaction made in the ordinary course of such business. For purposes of this section, the term “stock or securities” shall, except as provided in regulations, include contracts or options to acquire or sell stock or securities.”

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Wash Sale Concepts

Tax practitioners and compliance officers need to understand the following concepts in order to accurately apply the wash sale rule to securities transactions.

Branching

Branching occurs when a lot is broken into separate components (sub lots) based on the replacement lot size. Per the wash sale rule, when the replacement lot is larger than the original lot, only a portion of the replacement lot has its basis adjusted. Conversely, if the replacement lot is smaller than the original, then only a portion of the original loss is disallowed.

In the case where the replacement is larger, one sub lot (A) is created whose size is identical to the original lot. The other sub lot (B) contains the balance of the replacement lot’s position. Sub lot (A) has its cost basis and acquisition date adjusted according to the wash sale rules and sub lot (B) retains the original cost basis and acquisition date of the replacement lot.

In the case where the original is larger, it is also broken into two sub lots. The first sub lot (A) is created with a size equal to the replacement, and its loss is disallowed. The other sub lot (B) contains the balance of the original lot’s position and its loss may be recognized.

Note that in both cases, multiple sub lots can be created since multiple wash sales impact the same lot. In other words, the branches can branch.

Example — Branching

Activity:
  • 01/15/2005 Buy 100 shares of ABC at $100 per share.
  • 06/20/2005 Sell 100 shares of ABC at $90 per share.
  • 06/20/2005 Buy 200 shares of ABC at $90 per share.
Branching
Event Date Investment Quantity Event Type Total Amount
01/15/2005 ABC 100 Buy 10,000
06/20/2005 ABC -100 Sell -9,000
06/20/2005 ABC 200 Buy 18,000
Result:
  • The 200 share lot acquired on 06/20/2005 is considered to be two sublots, each containing 100 shares.
  • One carries a cost basis of $10,000 and an acquisition date of 01/15/2005 and the second with a cost basis of $9,000 and an acquisition date of 06/20/2005.
  • Should 100 shares be sold, the taxpayer may choose which sublot is disposed of.
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Chaining

The Chaining concept prevents taxpayers from circumventing the wash sale rule by simply selling the replacement lot to harvest deferred losses. There are "chained" or "rolling" wash sales. Chaining is the result of a consecutive series of Buy-Sell-Buy scenarios (Buy-Sell-Buy-Sell-Buy). There is no limit to the number of potential trades in a single chain. Chaining becomes especially complex when the cost adjustment to the original replacement Buy creates a subsequent wash sale. This occurs because the cost basis of the replacement Buy is increased by a sufficient amount to cause a subsequent sale to be a loss instead of a gain. This scenario creates additional replacement Buys, whose holding periods must be adjusted separately.

The chaining effect dictates that the cost basis adjustment affecting a replacement position must be taken into account when determining the amount of recognizable loss that occurs due to this position being retired. This can adjust forward the gain or loss from the retirement as well as change its character. Three potential effects can result. (1) If the position is disposed of for a gain, that gain can be reduced. (2) However, if the adjustment is deep enough, the gain can become a loss, which therefore makes the disposition a candidate for a new wash sale. (3) If the disposition was made at a loss, the amount of loss is increased. The interesting effect is that the original loss can be carried forward through a sequence of dispositions that can be viewed as a “chain.” Chains can occur over multiple years with no limit on the number of links.

Example — Chaining

Activity:
  • 01/15/2005 Buy 100 shares of ABC at $100 per share.
  • 06/20/2005 Sell 100 shares of ABC at $90 per share.
  • 06/20/2005 Buy 100 shares of ABC at $90 per share.
  • 02/15/2006 Sell 100 shares of ABC at $95 per share.
  • 02/15/2006 Buy 100 shares of ABC at $95 per share.
  • 01/05/2007 Sell 100 shares of ABC at $80 per share.
Chaining
Event Date Investment Quantity Event Type Total Amount
01/15/2005 ABC 100 Buy 10,000
06/20/2005 ABC -100 Sell -9,000
06/20/2005 ABC 100 Buy 9,000
02/15/2006 ABC -100 Sell -9,500
02/15/2006 ABC 100 Buy 9,500
01/05/2007 ABC -100 Sell -8,000

Result:
  • 06/20/2005 loss of $10,000 is disallowed.
  • 02/15/2006 sale qualifies as a $5,000 loss and is also disallowed.
  • 01/05/2007 sale is a $2,000 loss and is considered long term.
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Substantially Identical

Generally, securities are not considered 'substantially identical' if they are substantially different in any material feature, or because of differences in several material features considered together (i.e., even though each of such differences considered alone might not be regarded as substantial). Normally securities of two companies are not substantially identical, and preferred stock are not substantially identical to common stock. However, Publication 550 does call out some specific exceptions for mergers and convertible securities. There is no single source that provides a definition of substantially identical; the guidelines are spread across multiple different sources.

Example — Substantially Identical

Activity:
  • 02/01/2013 Buy 2¼ Bearer T-Bond Maturing 06/2023.
  • 06/24/2014 Buy 2¼ Registered T-Bond Maturing 12/2023.
  • 07/24/2014 Sell 2¼ Bearer T-Bond Maturing 06/2023 at a loss.
Substantially Identical
Event Date Investment Quantity Event Type Total Amount
02/01/2013 Bearer Bond (06/2023) 1.00 Buy
06/24/2014 Registered Bond (12/2023) 1.00 Buy
07/24/2014 Bearer Bond (06/2023) 1.00 Sell

Result:

By Revenue Ruling 58-211, this is a wash sale.

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History of Wash Sale Rule

Congress has had the legal authority to tax income of both individuals and corporations since 1913, when the 16th amendment to the U.S. Constitution made income tax permanent. Since then, Congress has attempted to encourage economic growth and thus increase tax revenue collection through key pieces of legislation. One example is the Revenue Act of 1921, which introduced the wash sale rule — one of the first tax shelters to be disallowed by Congress. Spearheaded by Andrew Mellon, the Secretary of the Treasury, the Revenue Act of 1921 was put in place as a way to spur economic activity after World War I. The Act set the groundwork for key aspects of our current system of taxation. It differentiated taxation of capital gains (the profit from buying and selling capital assets (investments and property)) from ordinary income. In an attempt to increase tax revenue collection, the Act created the wash sale rule as a way to stop sophisticated investors and taxpayers from committing tax fraud and creating securities transactions to lower their tax liabilities.

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Resources on Wash Sales

White Papers about Wash Sales

Basic Wash Sales This paper discusses the history behind this taxable event and key concepts, such as branching and chaining, which are critical to calculating disallowed losses.

Holding Period Adjustment Methods for Wash Sales When determining holding period adjustments as a result of wash sales, three methods can be used. This paper explores the intricacies involved in executing each method and pays special attention to ‘chained’ wash sale cases.

Advanced Topics in Wash Sales: Substantially Identical Bonds This paper discusses certain IRS and Tax Court rulings as well as the Code of Federal Regulations to illustrate the government’s thinking on the interaction between 1091(a) wash sales and debt securities with specific attention paid to how substantially identical applies.

Wash Sale Implications of Short Sales This paper discusses how Holding Periods, Delivery Wash Sales and Constructive Sales impact the highly complex and confusing process of determining whether or not a short sale will result in a wash sale. Through the use of examples, it aims to clarify the ambiguous IRS tax code on this subject.

Prospective Wash Sales Data on prospective wash sales can play a vital role in a tax-aware portfolio management strategy. This paper discusses the two types of events that can result in a prospective wash sale and provides examples to illustrate how to identify these tax events.

Wash Sale Concerns for Mutual Funds & DRIPs Mutual fund securities and dividend reinvestment plans acquired on or after January 1st, 2012 must include wash sales in cost basis calculations reported on 1099-Bs. Replete with examples of complex wash sale scenarios, this paper addresses critical issues involved in meeting this new cost basis reporting regulation.

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Webinars on Wash Sales

Wash Sales, Constructive Sales & Straddles: A Primer This webinar provides an overview of the aforementioned taxable events (Sections 1091, 1259 and 1092 of the IRC) and how they affect realized gains & losses.

Wash Sales: A Closer Look This webinar provides attendees with an in-depth look at wash sales and how they impact realized gains & losses.

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Video Clips on the Wash Sale Rule
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IRS & Legal Information Institute (LII) Resources on Wash Sales

Click here to access Pub 550, the IRS publication that provides information and guidance on complying with sections of the Internal Revenue Code (IRC) that pertain to investment income and expenses.

To read specifically about wash sales as described in Pub 550, click here.

Another useful on-line resource to research different sections of the IRC is the Legal Information Institute (LII) site, which is published by Cornell University Law School.

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