The wash sale rule (IRC Section 1091) prevents investors from selling a security at a loss to capture the tax benefit and immediately repurchasing the same security to maintain their investment position.
The rule: A loss on the sale of a security is disallowed if, within the period beginning 30 days before the sale and ending 30 days after the sale (a 61-day window), you purchase — or enter into a contract to purchase — "substantially identical" securities.
What is "substantially identical"? - The same stock or bond. - Options to buy the same stock (call options). - Convertible securities of the same company. - Generally NOT a different company's stock, even in the same industry.
What happens to the disallowed loss? - The disallowed loss is added to the cost basis of the newly purchased securities (it's deferred, not permanently lost). - The holding period of the new shares includes the holding period of the old shares.
Example: Buy 100 shares XYZ at $50 (cost: $5,000). XYZ falls to $40. Sell for $4,000 (loss: $1,000). Buy 100 shares XYZ back 10 days later at $42 (cost: $4,200). - The $1,000 loss is disallowed. - New cost basis = $4,200 + $1,000 = $5,200. - The loss will be recognized when the new shares are eventually sold (outside the wash sale window).
Tax-loss harvesting workaround: After selling at a loss, wait 31+ days before repurchasing, or buy a similar but not substantially identical security (e.g., a different S&P 500 ETF).
> Exam tip: The wash sale window is 30 days before AND after (61-day total). The disallowed loss is added to the new cost basis — it's deferred, not lost permanently. Key for CFP® and EA exam.