Wash-Sale Rules: What Investors Need to Know

The wash-sale rule is an IRS tax regulation that prevents investors from claiming a capital loss on a security if they buy back the same — or a substantially identical — investment within 30 days before or after the sale. The purpose of this rule is simple: to stop investors from creating “paper losses” just to reduce their taxes while keeping the same investment exposure.

For example, you cannot sell Apple stock at a loss on Monday and then buy it back on Friday, expecting to deduct the loss. The IRS considers this a wash sale and disallows the deduction.

Why the Wash-Sale Rule Matters for Tax Planning

Understanding the IRS wash-sale rule is critical for year-end tax planning. Many investors use tax-loss harvesting to offset gains, but if a trade triggers the wash-sale rule, the loss won’t count in the current year. Instead, the disallowed loss is added to the cost basis of the repurchased security.

For frequent traders, this can snowball into significant complications, leaving portfolios that appear tax-efficient on the surface but are ultimately restricted when filing taxes.

Practical Examples of the Wash-Sale Rule

Consider an investor who sells shares of a technology ETF on December 15th to capture a $5,000 loss, intending to repurchase in early January. If the repurchase occurs before January 14th, the wash-sale rule applies, and that $5,000 loss cannot be claimed for 2025. Instead, the loss is rolled into the cost basis of the new ETF shares.

While this may sound like an accounting technicality, it directly impacts future gains, potentially increasing taxable income when those shares are eventually sold.

Common Pitfalls to Avoid

The wash-sale rule isn’t limited to simply selling and rebuying the same stock. Investors often trigger it without realizing:

• Options trades: Buying a call or writing a put option tied to the same stock can create a wash sale.
• Dividend reinvestment plans (DRIPs): Automatic reinvestment of dividends into the same security can inadvertently violate the rule.
• Retirement accounts: Selling at a loss in a taxable brokerage account and then repurchasing in an IRA or Roth IRA within 30 days still counts as a wash sale. Even worse, the disallowed loss cannot be added to the IRA’s basis—it’s gone permanently.

Strategies to Avoid the Wash-Sale Rule

Investors can take practical steps to avoid disallowed losses:

• Use substitute securities: Replace one ETF with another offering similar exposure but not considered “substantially identical” (e.g., swap an S&P 500 ETF with a total market ETF).
• Wait out the 30-day window: Although this strategy carries market timing risks, it ensures losses remain valid.
• Coordinate across all accounts: Track activity in taxable accounts, IRAs, and even spousal accounts to prevent accidental violations.

Careful planning, record-keeping, and a watchful calendar can go a long way toward keeping tax-loss harvesting strategies effective.

Additional Points to Remember

Brokerages typically report wash-sale adjustments on Form 1099-B, but these reports may not capture activity across multiple accounts. Investors using more than one brokerage should not assume the reporting is complete.

Another challenge is the vague IRS definition of “substantially identical.” While selling Apple and buying Microsoft is clearly not a wash sale, replacing one S&P 500 ETF with another from a different provider may fall into a gray area. This uncertainty makes professional guidance valuable for active investors.

Turning Losses Into Long-Term Leverage

The wash-sale rule may seem like a technicality, but it has significant consequences for investors who actively trade or practice tax-loss harvesting. Awareness and strategic planning can transform potential pitfalls into opportunities. By using substitute securities, tracking accounts closely, and coordinating trades with a broader tax strategy, investors can ensure their efforts at loss harvesting actually deliver the intended tax benefits.

In investing—as in taxes—the small details often have the biggest impact. Staying mindful of the wash-sale rule helps investors turn market losses into a strategic advantage rather than a costly mistake.