Understanding Wash Sales: A Simple Guide for Investors

Aaron Engleman, Two Teachers' Tax Service
Mar 23
3 min read

If you invest in stocks or other securities, you’ve probably heard the term wash sale. It sounds technical, but the concept is actually pretty straightforward—and important when it comes to your taxes.

What Is a Wash Sale?

A wash sale happens when you sell an investment at a loss and then buy the same (or a “substantially identical”) investment within 30 days before or after the sale.

The IRS doesn’t allow you to claim that loss on your taxes right away.

Example:

You buy a stock for $1,000
You sell it for $700 (a $300 loss)
Then you buy the same stock again within 30 days

That $300 loss is disallowed for now.

How Wash Sales Affect Capital Gains

Short-Term vs. Long-Term Basics

Short-term gains/losses: Assets held 1 year or less (taxed at higher ordinary income rates)
Long-term gains/losses: Assets held more than 1 year (taxed at lower rates)

What Happens in a Wash Sale?

When a wash sale occurs:

Your loss is not gone forever. It gets added to the cost basis of the new investment.
Your holding period carries over

This can impact whether your future gain/loss is short-term or long term.

Example Continued:

Original loss: $300 (disallowed)
You repurchase the stock for $700
New cost basis becomes $1,000 ($700 + $300 disallowed loss)

When you eventually sell, that deferred loss will reduce your future gain (or increase your loss).

How Brokers Handle Wash Sales

Most brokerage firms automatically track wash sales for you and report them on your Form 1099-B.

Here’s how it typically works:

1. Automatic Detection - Brokers monitor your transactions and flag wash sales when:

The same CUSIP/security is repurchased within the 30-day window
The sale produced a loss

2. Adjustment to Cost Basis

When a wash sale is triggered, your broker will:

Disallow the loss on the sale
Add the disallowed loss to the cost basis of the replacement shares

This adjustment is usually shown on your 1099-B as:

A “W” code (indicating a wash sale)
An adjustment amount that increases your basis

3. Holding Period Carryover

Brokers also typically:

Transfer the original holding period to the new shares
This helps determine whether the eventual sale is short-term or long-term

Important Limitations to Know

Brokers do a good job—but they are not perfect:

They usually track wash sales only within the same account
They may not track across different brokers
They generally do not track wash sales involving IRAs or a spouse’s account

This means the final responsibility is still on the taxpayer to ensure wash sales are correctly reported.

Why This Matters

Wash sale rules prevent investors from:

Selling just to claim a tax loss
Immediately rebuying the same investment to keep their position

In short, the IRS wants to stop “tax-loss harvesting” without a real economic change.

How to Avoid Wash Sales

Here are some simple, practical strategies:

1. Wait 31 Days

The safest option:

Sell the investment at a loss
Wait more than 30 days before buying it back

2. Buy a Similar—but Not Identical—Investment

You can maintain market exposure without triggering a wash sale.

Example:

Sell one S&P 500 ETF
Buy a different ETF that tracks a similar (but not identical) index

3. Turn Off Automatic Reinvestment

Dividend reinvestment plans (DRIPs) can accidentally trigger wash sales if:

You sell at a loss
Dividends automatically repurchase the same stock within 30 days

4. Watch All Accounts

Wash sale rules apply across:

Taxable brokerage accounts
IRAs
Even accounts held by a spouse

A purchase in one account can trigger a wash sale on a sale in another.

Final Thoughts

Wash sales don’t eliminate your losses—they just delay when you can use them. Most brokers help by automatically adjusting your cost basis and flagging transactions, but those systems have limits.

Understanding both how the rule works and how it’s reported will help you: