The wash sale rule is an IRS taxation regulation governing the use of investment losses in capital gains tax. The wash sale rule prohibits the investor from claiming any sale of a security as a loss if a similar security is purchased within 30 days of the sale.
The wash sale rule also applies to security purchases by a spouse or an owned company.
The wash sale rule is intended to stop traders from gaming the capital gains taxation system.
The IRS definition of a similar security is limited in scope. The wash sale rule is mostly concerned with derivatives on the original security that provide similar exposure to that security, such as a call option or warrant. Preferred and common stock are also usually considered similar enough to qualify for the wash sale rule.
The bonds of the company or the shares of a similar company do not qualify as part of the wash sale rule.
Wash Sale Rule Enforcement
If a capital gains claim made for a trading loss is determined to fall under the wash sale rule, the value of the loss will be added to the price of the newly purchased security for taxation purposes.
For example, if a stock was originally bought at $10 and then later sold for $8, the loss for capital gains taxation purposes would be $2.
However, if the same or similar security was purchased for $9 within 30 days of the sale, then the price of the stock would be considered to be $11 for the purpose of determining capital gains taxation.
The wash sale rule is an example of the many taxation regulations that are important for day traders to know and understand.
Tax regulations will have a major impact of a day trader’s final profitability, and it is critical that they follow all IRS regulations governing the use of trading profits and losses in taxation.