Wash Sale Rule for Traders

Wash sale rule or 30-day wash-sale rule is a tax rule imposed by Internal Revenue Service (IRS) on traders and investors. As per the rule a trader/investor can’t claim tax reduction for the loss of a trade if he purchases back the same instrument (replacement instrument) with in a wash sale period. Wash sale period includes 61 calendar days – 30 days before the sale date and 30 days after the sale date.

Wash sale rule mostly seriously affects traders and investors who trade stocks of a limited chosen companies and day traders who buy and sell different stocks in large numbers. Apart from prevention of tax deduction, wash sale rule has two other consequences.

1. Basis adjustment – Trader’s disallowed loss is added to the basis of replacement instrument. This preserves the benefit of disallowed loss on future sale of replacement instrument.
2. Holding period – Trader’s holding period for the replacement instrument includes the holding period of sold instrument. This prevents traders from altering long-term loss to short-term one.

Wash sale rule do not applies to financial instruments like futures and currencies. Many traders adopt different of strategies to minimize the effect of wash sale rule; as (1) calendaring the sales and purchase dates with minimum trading days involved, (2) buying replacement stock only after confirming the stock price is at bottom level, and (3) buying some other stock which has great correlation with original stock and then replacing that with original stock after completion of wash sale period.

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