What is the wash sale rule?

A wash sale is defined as one that occurs when a taxpayer sells a security at a loss and within 30 days before or after buys the same stock. Therefore the wash sale period is really 61 days, 30 days before to 30 days after the sale. The loss on the sale is not deductible but it is not lost completely as the realized loss is then added to the cost basis of the newly acquired stock.

How did the wash sale rule come about?

The wash sale rule is an Internal Revenue Service regulation designed to prevent a taxpayer from taking a tax loss for a security sold in a wash sale. The intent of the wash sale rule is to prevent a taxpayer from claiming an artificial loss. Therefore the wash sale period is really 61 days, 30 days before to 30 days after the sale.

How does this wash sale rule work?

Here is a simple example of the computation that takes place during the application of the wash sale rule:   A taxpayer buys 100 shares of ABC Company on November 15th for $15,000. On December 20th the shares decline to $12,000 and are sold   to realize the $3,000 loss.

However on December 27th, the taxpayer buys back the 100 shares for $12,200.  Therefore the $3,000 loss would not be allowed under the wash sale rule, but would be added to the cost basis of the new shares.  The new cost basis of $12,200 plus the $3,000 loss that was disallowed will give you a new cost basis of $15,200.