Wash sale

A wash sale (not to be confused with a wash trade) is a sale of a security (, bonds, options) at a loss and repurchase of the same or substantially identical security shortly before or after.  The regulations around wash sales are to protect against an investor who holds an unrealized loss and wishes to make it claimable as a tax deduction within the current tax year. The security is then repurchased in the hope that it will recover its previous value, which would only become taxable in some future tax year. A wash sale can take place at any time during the year. In the UK, a similar practice which specifically takes place at the end of a calendar year is known as bed and breakfasting. In a bed-and-breakfasting transaction, a position is sold on the last trading day of the year (typically late in the trading session) to establish a tax loss. The same position is then repurchased early on the first session of the new trading year, to restore the position (albeit at a lower cost basis). The term, therefore, derives its name from the late sale and early morning repurchase.

In some tax codes, such as the USA and the UK, tax rules have been introduced to disallow the practice (e.g. if the stock is repurchased within 30 days of its sale). The disallowed loss is added to the basis of the newly acquired security.

In the USA wash sale laws are codified in "26 USC § 1091 - Loss from wash sales of stock or securities." The corresponding treasury regulations are given by CFR 1.1091-1 and 1.1091-2.

Under Section 1091, a wash sale occurs when a taxpayer sells or trades stock or securities at a loss, and within 30 days before or after the sale:

The "substantially identical stock" acquired in any of these ways is called the "replacement stock" for that original position.

In USA, the wash sale rule has the following consequences:

After a sale is identified as a wash sale and if the replacement stock is bought within 30 days before or after the sale then the wash sale loss is added to the basis of the replacement stock. The basis adjustment is important as it preserves the benefit of the disallowed loss; the holder receives that benefit on a future sale of the replacement stock.

Note: The identification of a wash sale and adjusting the basis of the replacement stock is an iterative process. Thus, the sale of the replacement stock (after its basis is adjusted) can also be identified as a wash sale if it meets the above criteria.

Example: Some time ago you bought 80 shares of XYZ at $50. The stock has declined to $30, and you sell it to take the loss deduction. But then you see some good news on XYZ and buy it back for $32, less than 31 days after the sale. You can't deduct your loss of $20 per share. But you add $20 per share to the basis of your replacement shares. Those shares have a basis of $52 per share: the $32 you paid, plus the $20 wash sale adjustment. In other words, you're treated as if you bought the shares for $52. If you end up selling them for $55, you'll only report $3 per share of gain. And if you sell them for $32 (the same price you paid to buy them), you'll report a loss of $20 per share.

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Wikipedia