What is a Wash Sale?

The concept of the wash sale involves selling off some type of security at a loss. This action would occur near the end of the current tax year. At the same time, the process will involve purchasing the same or a very similar stock in a very short period of time. Designed as a means of creating a capital loss that can be claimed on the tax return for the covered period, the idea is to offset the overall capital gains for the tax year, while still managing to keep the security in the investment portfolio for future use.

Over time, some steps have been taken to control the process of the wash sale. For example, there are now provisions in tax codes in the United States and the United Kingdom that will disallow wash sales if the stock, bond, or option is repurchased within thirty calendar days of the sale. This is true even if the period between the sale and the repurchase occurs at the end and the beginning of two tax years. When the wash sale is disallowed, the amount of loss is added to the basis for the repurchased acquisition, an approach that definitely serves as an effective deterrent.

In some countries around the world, the transaction of a wash sale is not only closely monitored, but also considered to be illegal. When this is the case, brokers will not participate in the transaction of a wash sale, even if it involves an international security. Generally, the wash sale will be considered to be illegal if it is obvious that the only reason behind the action is to avoid paying taxes on the return generated by the stocks or bonds that are sold at a loss and subsequently repurchased.

An investor may choose to utilize a wash sale to deal with marginable stocks that have not performed up to expectations, but are anticipated to improve in the coming calendar year. A broker will arrange the sale at a loss, then also arrange for the repurchase in a specified period of time. In all cases, the broker will work within the perimeters established by the Federal Reserve or the highest level of revenue and tax authority in the jurisdiction.