What Is a Wash?
A wash is a series of transactions that results in a net sum gain of zero. An investor, for example, can lose $100 on one investment and gain $100 in another investment. That's a wash. But the tax implications can be complicated for the investor.
A wash is also referred to as a break-even proposition.
Understanding the Wash
When it's a wash, two transactions cancel each other out, effectively creating a break-even position.
- In investing, a wash is a loss that is canceled out by an equal gain.
- For tax purposes, a wash is an investment loss that can be used as a deduction.
- There are time restraints on an investor's ability to deduct the loss if the same stock is purchased again.
If a company spends $25,000 to produce merchandise and sells it for $25,000, the result is a wash. If an investor loses $5,000 on the sale of an investment and gains $5,000 from the sale of another the transaction has been washed.
That's simple enough but the IRS has complicated tax rules regarding wash sales by investors, and they are related to the claiming of losses on investments. Specifically, the rules prevent an investor from claiming a loss if they sell a security at a loss and then repurchase the same security or one that is substantially identical within 30 days.
For example, say an investor buys 100 shares of Anheuser-Busch (BUD) stock for $10,000. Just six weeks later, the value of the 100 shares declines to $7,000. The investor sells all 100 shares hoping to deduct the capital loss of $3,000 at tax time but then, a week later, decides BUD is a real bargain and buys 100 shares again.
The initial loss cannot be claimed for tax purposes since the same security was repurchased within the limited time interval.
An investor can't sell a stock at a loss, buy the same stock again within 30 days, and still claim the loss as a deduction.
However, the loss realized from a wash is not completely wasted. The loss can be applied to the cost basis of the second purchase of BUD. That increases the cost basis of the purchased securities and therefore will reduce the size of any future taxable gains when the stock is sold. The benefit of the wash has been delayed but it hasn't disappeared.
In addition, the holding period of the wash securities is added to the holding period of the replacement securities. In this example, the investor has added six weeks to the holding period of that stock, making it that much easier to qualify for the 15% favorable tax rate on long-term capital gains. (Stock must be held for one year to qualify for that lower tax rate.)
When a Wash Is Illegal
Some wash sales are illegal because they resemble a pump and dump scheme.
For example, an investor cannot buy a stock using one brokerage firm and then sell it through another brokerage firm for the purpose of stimulating investor interest.