The wash sale rule does not have to do with day trading or investing strategies. Rather it is a regulation of the Internal Revenue Service meant to discourage investors and traders from selling a stock or stock option simply for the purpose of taking a tax loss and then immediately purchasing that security again. The wash sale rule does not forbid selling a security that has incurred either a short term or long term loss but rather from taking a tax loss after re-purchasing that same security within 30 days.

What Is the Wash Sale Rule?

The wash sale rule applies to trading stocks and trading options. It does not apply to commodity futures or to trading foreign currencies. The IRS does not forbid you from selling a stock or stock option on which you have taken a loss. Rather it forbids you from declaring that loss on your taxes should you turn right around (within up to 30 days) and purchase the same stock or stock option. If you have a both a gain and a loss on the same stock within 61 days the wash sale rule also applies.

Wash Sale Rule Day Trading

The wash sale rule forbids you from taking a tax loss on a stock which you have held for months or years if you sell it and purchase it again inside of 31 days. But, for stock day traders who may have held the stock before and sold it at a profit, it gets worse. You traded the stock once for a profit and decided to take advantage of a price swing and trade it again. But, this time you sold the stock at a loss. Should you wish to try this a third time you need to wait for 61 days or you cannot declare a tax loss on time when your trade lost money.

Wash Sale Rule for Gains

You trade a stock for a profit. If you had taken a loss you would not be able to declare that loss on your taxes if you purchased the stock again within 30 days. Because you made a profit on the trade and sold the stock you probably decide to try the same trade on the same stock. Sadly, you exit the trade for a loss. So, you decide to trade stock options on the same stock to avoid the wash sale rule. In this case, you can expect to get an argument from the IRS unless  you waited 61 days to initiate the trade as the rule applies equally (with stocks) to direct trades and options and applies to 30 days before and 30 days after! Again, the rule does not apply to trading commodity futures!

Wash Sale Rule for Losses

The wash sale rule for losses is not meant to keep you from getting out of a stock that is on a downward slide. Rather the IRS does want you to sell a stock at the end of the year and immediately re-purchase it in order to take a tax loss. Because there are times when it is wise to exit a stock position during a downward trend, traders need to be aware that if they are waiting for the stock to hit bottom before they purchase it again they need to take into consideration the wash sale rule for losses.

Wash Sale Rule Penalty

The IRS does not have a specific penalty that they apply in case of a wash sale rule violation. But, you will have to redo your taxes and pay more because you were not able to deduct the loss due to the wash sale rule. If you were to repeatedly violate this rule the costs would mount up but the IRS does not have a specific rule for penalizing those who repeatedly sell and buy stocks at a loss within the specified 30 day period. To get into more trouble with the IRS you need to have taken steps to hide this information or otherwise tried to avoid paying taxes.

Wash Sale Rule Examples

All wash sale rule examples apply to stocks and stock options and not to commodity futures or Forex trading. The rule applies if you bought Microsoft at $185 just before the onset of the Covid crisis, sold it for $137.35 when the market hit bottom, and then purchased it as soon as the Fed opened the spigot with their rescue package. The wash sale rule does not forbid you from buying and selling stocks or trading stock options however you wish. It does forbid you from taking a tax deduction on losses when you immediately re-purchased the stock.

Wash Sale Rule Calculator

This is something that commodity futures trades need not worry about but busy day traders need to. There are several software packages that download your brokerage account’s trade data and track your current tax status for the year. In the case of wash sales the only issue is to know which trades fall within the 31 day limit or the 61 day limit for stock and options trades. A wash sale rule calculator can help you avoid a lot of work at tax time and a lot of later surprises when the IRS finds that you broke their rule!

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