What Is the Wash Sale Rule? How Does It Work?

 A wash sale rule is often a concern for people trading stocks and securities. It’s a rule enforced by the Internal Revenue Service (IRS) to prevent people from abusing tax rules in capital gains. Learning about them will provide you with the edge you need.

Table of Contents

• What is a Wash Sale?

• What Types of Investments are Subject to Wash-Sale Rules?

• Are Cryptocurrencies Subject to Wash-Sale Rules?

• What if I Sell Shares in a Taxable Account and Purchase them in a Retirement Account?

• What is the Wash Sale Penalty?

• How Do You Avoid a Wash Sale?

What is a Wash Sale?

Often, when you sell a security for a loss, you’ll get tax deductions stemming from it. However, people would begin abusing these deductions to try and lower their taxes. They will sell for a loss to claim the benefit then immediately rebuy to keep their investment. To counteract, the IRS created the wash sale rule.

A wash sale occurs when you sell a security for a loss but rebuy it within 30 days. If you do this, the capital losses to offset will not count. Rebuying substantially identical securities within the timeframe will wash the subsequent loss. The rule applies 30 days before and after the sale date, the so called 61-day window. You’ll have to hold the security for at least 30 days for it to count.

The rule applies whether it is the individual that sells or another entity connected. It’s still considered a wash if the spouse or an individual's company does the transaction.

The loss will still count but will become a part of the new purchase. It will carry over until the position liquidates after more than 30 days.

What Types of Investments are Subject to Wash-Sale Rules?

The wash-sale rule doesn’t apply to all forms of investments. They must be from an individual retirement account (IRA) or a non-qualified brokerage account. As long as they are from there, any stock or security is under the wash-sale rule. It applies to the investor and not each account in case they have several.

Are Cryptocurrencies Subject to Wash-Sale Rules?

 Stocks and securities are subject to the wash sale rule. However, cryptocurrencies are not either of those. Instead, for taxation purposes, cryptocurrencies fall under property tax rules. Because of that, investors in crypto shouldn’t worry about wash sales.

You can safely use tax-loss harvesting as a strategy to lower taxes in cryptocurriences. You can sell an asset for a loss before the tax deadline and later rebuy it for the new year. The reason the IRS cannot impose wash-sale rules is that crypto is a more volatile asset. It doesn’t have the same stability shown by most securities since it’s a new market.

The stance on it can change in the future, but for now, crypto remains untouched. The current environment allows investors to enjoy crypto without worrying about wash sales.

What if I Sell Shares in a Taxable Account and Purchase them in a Retirement Account?

The wash sale rule applies if the individual acquires a contract to buy substantially identical stocks or securities. Transferring the money from a taxable account to a retirement one will not work. Instead, it’s considered a wash sale. The rules also state that if you get identical stock for your IRA or Roth IRA, it will still be a wash sale. As long as it is within the 30-day timeframe, it will apply.

What is the Wash Sale Penalty?

The penalty doesn’t have anything to do with money. Instead, the IRS revokes the loss on the sale if they determine that a wash sale occurred. For now, the loss will not apply to your taxable income from the year. It adds to the cost basis of the new investment.

While you cannot take advantage of the losses right away, it can still benefit you in the long run. If you buy at a higher cost basis, you can get more if you realize a larger loss.

Even if you gain on the investment in the long run, the holding period can help reduce the cost. The investment can even qualify for a long-term capital gains tax rate if held long enough.

How Do You Avoid a Wash Sale?

Avoiding a wash sale can be a tricky endeavor. Even if you swap mutual funds for another, it may still fall under the wash sale due to being substantially identical. The same is true for an exchange-traded fund (ETF). There is no clear guideline on this, but there is a method that some people use.

If you are looking to avoid a wash sale on an individual stock, one thing to do is substitute a mutual fund for an ETF. Some ETFs focus on specific industries or stocks, avoiding the substantially identical rule. However, the ETF you choose must have enough securities to qualify.

If the IRS believes that it’s still identical and applies the wash, there’s nothing you can do about their judgment. However, doing the mutual fund to ETF move will give you a better chance. If you want more assurance for avoiding wash sales, then having tax professionals at your side will be the best option.

Conclusion

Wash sales can have complications, and you can improve your chances of navigating it by hiring tax professionals. Core Group has helped many investors secure capital losses legally.

We understand the nuances in wash sale rules. We have the experience to know what strategies work and what pitfalls to avoid. Contact us today and have a specialist guide you through our services and process.