What is a wash sale?
If you sell company shares for a loss and buy more company shares within 30 calendar days before or after the loss transaction (i.e. a 61-day window), the federal tax code will at least temporarily deny you the ability to claim your loss on the sale for the number of shares replaced. Instead, your loss and the holding period for these shares will be carried over to increase the tax basis of the replacement shares (see IRC Section 1091).
The wash sale rule applies to all securities. Its purpose is to prevent you from taking unfair advantage of tax-loss harvesting to sell stock at a loss, reducing your taxes for the year, and then quickly buy it again.
You realize the previously disallowed loss by paying less tax on the later sale of the replacement shares. For purposes of determining whether the gain or loss upon the sale of the new shares is short-term or long-term, you tack on the holding period of the loss shares you sold to the holding period of the replacement shares.
Example: You have 100 shares of company stock with a tax basis of $20 per share from an NQSO exercise, restricted stock vesting, or open-market purchase.
- You sell it at $10 per share.
- The IRS will not allow you to deduct the $1,000 loss if within 30 days of the sale (i.e. before the 31st day) you purchase, for example, another 100 shares of company stock for $12 per share.
- Instead, you increase the tax basis of the replacement shares by $1,000 (i.e. by $10 each, to $22 per share) and pay less tax on the replacement shares when you sell them.
- Sell the 100 replacement shares for $4,000 ($40 per share): capital gains tax on $1,800 from their sale because your tax basis would be $2,200 (100 x $22), not $1,200.
- Buy back only a portion of the stock you sold (e.g. 50 shares): only that portion would trigger the wash-sale treatment for the same number of repurchased shares (i.e. 50 shares), not for the entire number of 100 shares initially sold.
Be Careful Of What You Repurchase
The rules are triggered when you buy "substantially identical securities" (not just stock) before or after the loss. Purchasing call options, selling deeply in-the-money put options, and making short sales all raise issues (see an article in Investment News). Even buying the same stock in a retirement account, such as a 401(k) or IRA (Roth or IRA), will violate the wash-sale rule, as the IRS stated in Revenue Ruling 2008-5. Also, you cannot add this loss to the basis of the shares purchased in your IRA, which would permanently eliminate the disallowed capital-loss amount. To avoid wash-sale treatment, you can instead buy the stock of another company in the same industry or in a mutual fund or exchange-traded fund (ETF) tracking that industry.
Alert: If you are resetting the basis in your stock, you may be tempted to sell your appreciated shares and then quickly repurchase the stock. While you may be concerned about the wash-sale rule, it applies only to stock sold at a loss. That means you can sell stock at a gain and then immediately repurchase it without wash-sale problems.
How The Wash-Sale Rule Applies To Stock Options, ESPPs, And Restricted Stock
In addition, IRS Revenue Ruling 56-452 can be read broadly as covering stock grants and exercises, including ESPP purchases. For example, a cashless exercise of stock can result in a small loss for the commission, and this can have wash-sale implications if it occurs close to new stock grants. With ESPPs, a sale at a loss before a new ESPP purchase can also trigger a wash sale. However, this old IRS ruling concerned "restricted stock options," which are not often used any more. IRS Revenue Ruling 73-329 could more analogously apply to restricted stock (see a related FAQ), though its focus is on the wash-sale impact of bonus shares granted. Therefore, the application of these revenue rulings to the vesting of restricted stock or performance shares is uncertain (speak with your tax advisor about it). Sales of stock received in an ISO exercise raise additional issues under the wash-sale rules, which apply when the sale price of the ISO stock is above the exercise price but below the market price at exercise.
In IRS Publication 550, the IRS guidance on wash sales, located in the subsection "Capital Gains & Losses" in Chapter 4 (page 58 in the 2017 version), covers bonus stock (see Example 2) and options to acquire stock. This guidance indicates to some experts that the IRS does view the wash-sale rules as applicable to restricted stock and stock options. In addition, while your brokerage firm will track and report wash sales within your account, it may not do so across different accounts you have at that firm and at others. Therefore, transactions in your stock plan account may not be tracked for wash sales against your trades in your retail brokerage account. This requires you and/or your tax-return preparer to consider trading activity in company stock across all the accounts you have.
IRS Form 1099-B includes Box 1g for the amount of any nondeductible loss stemming from a wash sale involving covered securities (at least those in the same account). The cost-basis reporting of wash sales on Form 1099-B, particularly when a noncovered security such as restricted stock is involved, remains uncertain.
Alert: You still need to report the sale on your tax return even though the loss for those shares at that time will not be recognized.
On Form 8949, to report sale with your Form 1040 the special rules include:
- In column (f), enter "W" to indicate transaction is wash sale.
- In column (g), enter as a positive number the adjustment for the currently nondeductible part of the wash sale.
For further details, see the IRS instructions for Form 8949: the subsection How To Complete Form 8949, Columns (f) and (g). See also the IRS instructions for Form 1099-B, which have an example on Form 1099-B in the section "Box 1g. Wash Sale Loss Disallowed."
The repurchased shares have their basis increased because of the wash sale. When you sell those shares, you want to confirm that the broker's basis-reporting system and 1099-B factor in the basis adjustment for the previously disallowed loss.