Beware of the Wash Sale Rule When Harvesting Tax Losses

Details of the Rule

For federal income tax purposes, a loss from selling stock or mutual fund shares is disallowed if you buy substantially identical securities within a 61-day period. This period begins 30 days before the date of the loss sale and ends 30 days after that date.  

When you have a disallowed wash sale loss, the loss doesn’t just disappear (except when your IRA or controlled corporation acquires the substantially identical securities, as explained later). Instead, the general rule is that the disallowed loss is added to the tax basis of the substantially identical securities that triggered the wash sale rule. When you eventually sell the substantially identical securities, the additional basis reduces your tax gain or increases your tax loss. 

For example, suppose you bought 1,000 shares of ABC Co. on July 5, 2023, for $25,000 using your taxable brokerage account. The shares plummet. You harvest what you assume is a tax-saving loss by selling the shares on December 15, 2023, for $15,000. The amount of your loss is $10,000 ($25,000 tax basis minus $15,000 selling price). You plan to use the $10,000 loss to shelter an equal amount of 2023 capital gains from other successful stock trades. After you incur the loss, you reacquire 1,000 shares of ABC Co. for $15,500 on December 22, 2023, because you still like the company. Can you claim the $10,000 capital loss on your 2023 federal income tax return? Unfortunately, the wash sale rule disallows your capital loss deduction. The disallowed loss increases the tax basis of the substantially identical securities — the ABC Co. shares that you acquired on December 22, 2023. The tax basis of the shares would be $25,500 (the cost of $15,500 plus the disallowed wash sale loss of $10,000).

2 Ways to Defeat the Rule

The wash sale rule is an issue only when you want to sell a stock or security to harvest a tax-saving capital loss, but you buy it back because you expect the price to increase in the future. There are two possible workarounds:

1. The “double up” strategy. You could buy the same number of shares in the stock that you want to sell for a loss. Then, you’ll need to wait 31 days to sell the original shares. In the end, you’ve made your tax-saving loss sale, but you still own the same number of shares and can benefit from the anticipated future appreciation.

Let’s say you want to sell the ABC Co. shares that you currently own for a 2023 tax-saving capital loss. But you don’t want to give up on the stock. So, on November 21, 2023, you buy 1,000 more ABC Co. shares. Then you can sell the original 1,000 shares for a tax-saving loss any time between December 22, 2023, and the last day of the year that the stock market is open. The wash sale rule is avoided because your sale date will be more than 30 days after the day that you purchased the additional shares (November 21, 2023). 2. The “call option” strategy. A less-expensive way to achieve essentially the same tax-saving goal is to buy a call option on the stock you want to sell for a 2023 tax loss. Then, you’ll need to wait more than 30 days to sell the stock. As the owner of a call option, you have the contractual right, but not obligation, to buy that stock at a specific price up until a defined expiration date.