When do taxes matter in investing? The short answer is always. After all, they can erode returns, and they pose a significant risk to high-net-worth and other tax-sensitive investors. So it’s vital for advisors to pay close attention to tax management at all stages of a portfolio’s life cycle.

Often this involves harvesting losses in the portfolio to offset gains—that is, selling a money-losing stock and then using the loss to reduce capital gains tax liability from any sales of appreciated stock. But what if the investor wants to harvest a loss but doesn’t want to lose the position in that particular equity holding? Can you sell a holding at a loss and then buy back that same stock shortly after to reestablish the position? Thanks to the IRS’s wash-sale rule, the answer is no.

What is a Wash Sale?

A wash sale occurs when an investor sells a security at a loss and then repurchases that security—or one that’s “substantially identical” to it, in the parlance of the IRS—within 30 days before or after the sale. In these situations the IRS requires investors to add the amount of the loss to the cost basis of their original holding, thus negating the loss’s tax benefit.

What’s more, it doesn’t matter whether the investor purchases stock in different lots. As long as the sale is within 30 days of any purchase, it could be considered a wash sale. Let’s look at a few wash-sale examples.

Example 1: Wash sale triggered by sale

 

Wash Sales

January 1: Buy 100 shares

of XYZ at $100 per share (Lot A)

Wash Sales

June 1: Buy 10 shares

of XYZ at $95 per share (Lot B)

Wash Sales

June 15: Sell 10 shares

of XYZ (Lot A) at $90 per share for a total loss of $100

Example 2: Wash sale triggered by purchase

Wash Sales

January 1: Buy 100 shares

of XYZ at $100 per share (Lot A)

Wash Sales

June 1: Sell 10 shares

of XYZ (Lot A) at $92 per share for a total loss of $80