What Are Wash Sales?

To keep investors from taking advantage of the benefits of tax selling, the Internal Revenue Service created the wash sale rule.

The wash sales rule makes you wait 30 calendar days after you've sold a security for the tax loss before you can repurchase the same security or a “substantially identical” one. You can buy it back on the 31st day after the sale, however.

The wash sale rule also applies to the 30-day period before you sell a stock to prevent you from buying twice as much stock as you want and selling half of it for tax benefits.

Be aware that the IRS does not clearly define a “substantially identical” security. Compare the performance graphs of your old stock and the one you're considering. If they look nearly identical, keep looking.

The IRS also frowns on indirect sales to a related party, so your spouse, your IRA, or the corporation you control can't buy back tomorrow what you sold today.

You are permitted to buy a replacement stock within the wash sale period. This security shares the same asset class, industry, or sector as the one you sold. For example, you could sell one computer manufacturer stock, then buy a competing company or exchange-traded security.

If you violate the wash sale rule, the IRS forbids you from deducting the loss that year. But you can take the loss at a later time.

There are risks

• The security you sold might go up in price during the wash sale period, forcing you to pay more to buy it back.
• Replacement stocks can move independently of the market. Corporations can be hit with bad news specific only to them, not to their competition.
• Paying commissions both when you sell off the security and then buy it back may wipe out any tax loss benefits.
• Tax selling is logical if you have a taxable account. Don't use your IRA or 401(k).

Tax savings should never be your primary concern when making investment decisions, however. Focus on your long-term goals.