Is the wash sale rule canceled by something if you don't hold the stock in question for 30 days?

Question

Suppose an inverstor in USA buys 100 shares in XYZ for $50 each. Two weeks later XYZ is doing terribly, and the investor gets cold feet and sells the shares for $40 each, at a total loss of $1000.

Because the sale of XYZ stock happened less than 30 days after he bought XYZ stock, it is classified as a wash sale according to 26 U.S.C. 1091(a), and therefore the investor is not allowed to deduct the loss.

I am seeing insistent claims that the investor is nevertheless allowed to deduct his $1000 loss once he has gone 30 days without owning any XYZ stock, but I cannot find any actual rule that says so.

Does such an exception from the wash-sale rule exist, and if so what is its statutory or regulatory basis?

Answer 1

You are misunderstanding what constitutes a wash sale. In your example, the wash sale rules do not apply (as long as you don't buy the stock again for 30 days after the sale).

Let's say that you bought your 100 shares of XYZ for $50 each. At some point in the future, the price drops to $40. You think that the price will bounce back and you want to continue to hold, but you would like to deduct the loss on your taxes. Therefore, you decide that you will sell XYZ at $40 (for a total loss of $1000), but you repurchase the stock again (also at $40). The transaction cost you nothing (as you sold and bought at the same price), and you still own 100 shares of XYZ, but now you think you have a $1000 loss to deduct. However, the wash sale rule exists to prohibit the deduction under this circumstance.

In your example, at the end of the story the investor no longer owns the stock. Therefore, as long as 30 days go by without him owning the stock, the wash sale rules do not apply. The investor legitimately lost $1000, and can take the deduction. After 30 days go by, the investor is free to buy again, if he wishes, and start a brand new cost basis.

Here is how to correctly parse the tax code you cited:

26 U.S. Code § 1091 - Loss from wash sales of stock or securities

(a) Disallowance of loss deduction

In the case of any loss claimed to have been sustained from any sale or other disposition of shares of stock or securities where it appears that, within a period beginning 30 days before the date of such sale or disposition and ending 30 days after such date, the taxpayer has acquired (by purchase or by an exchange on which the entire amount of gain or loss was recognized by law), or has entered into a contract or option so to acquire, substantially identical stock or securities, then no deduction shall be allowed under section 165 unless the taxpayer is a dealer in stock or securities and the loss is sustained in a transaction made in the ordinary course of such business. For purposes of this section, the term “stock or securities” shall, except as provided in regulations, include contracts or options to acquire or sell stock or securities.

The 100 shares that you sold at a loss were the 100 shares that you purchased 2 weeks earlier. That purchase transaction doesn't count. You legitimately have a "loss claimed to have been sustained from any sale or other dispostion of shares of stock." The next part of the sentence says, "where it appears that, within a period..., the taxpayer has acquired... substantially identical stock or securities, then no deduction shall be allowed." This has not happened. You did not dispose of some shares, and then within the period purchase additional identical shares. You had no shares to start, you bought them, you sold them at a loss, and ended with no shares. This is not a wash sale under these rules. The shares that you purchased 2 weeks earlier was not a purchase of substantially identical shares. It was the initial purchase of the shares that you sold.

The tax code is very hard to read, and can be misleading if you aren't used to looking at it. The IRS issues publications that are intended to be more clear and easier to parse. IRS Publication 550 has this to say about wash sales:

A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale you:

• Buy substantially identical stock or securities,

• Acquire substantially identical stock or securities in a fully taxable trade,

• Acquire a contract or option to buy substantially identical stock or securities, or

• Acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA.

It says that in order to have a wash sale, you must sell the stock at a loss and you must acquire substantially identical stock within the window. In your example, the second part has not occurred. The investor sold the stock at a loss, but he did not acquire substantially identical stock. The first purchase was the purchase of the stock he sold for a loss.

The publication goes on to list 4 examples, each of which shows a wash sale. In every example, the investor is shown buying stock at some point in the past that is not in the window. It is the purchase of additional identical shares before or after the sale of the old shares that makes it a wash sale.

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Here is the important thing to note about the wash sale rule that you may be missing. Yes, the wash sale rule, when triggered, prevents you from taking a capital loss deduction. However, it does not prevent you from taking the loss forever; instead, you add the loss to the cost basis of the shares you still have.

For example, let's say that I buy 100 shares of stock for $50. A year later, I sell those 100 shares for $40, and just before I did that, I purchased 100 shares at $45. Wash sale rules prevent me from deducting the loss now, but I can take that $10 per share loss and add it to the cost basis of the shares I still have. The cost basis of the 100 shares I have is now $55, and when I sell them in the future, this reduces the capital gain I will have (or increases the capital loss).

In your example, there are no remaining shares with which to add on to the cost basis. The wash sale rule doesn't even make sense in this scenario, because there is nothing remaining on which to tack on the loss.

Answer 2

You do not understand what a wash sale is.

The first paragraph of your link provides the answer.

(a) Disallowance of loss deduction

In the case of any loss claimed to have been sustained from any sale or other disposition of shares of stock or securities where it appears that, within a period beginning 30 days before the date of such sale or disposition and ending 30 days after such date** , the taxpayer has acquired (by purchase or by an exchange on which the entire amount of gain or loss was recognized by law), or has entered into a contract or option so to acquire, ** substantially identical stock or securities** , then no deduction shall be allowed under section 165 unless the taxpayer is a dealer in stock or securities and the loss is sustained in a transaction made in the ordinary course of such business. For purposes of this section, the term “stock or securities” shall, except as provided in regulations, include contracts or options to acquire or sell stock or securities.

The disallowance occurs because of the acquisition of a second lot of the security involved in the loss.

In your example of purchasing 100 shares of XYZ for $50 each and selling them two weeks later for $40 each, there is no second purchase hence there can be no wash sale. The is simply a capital loss of $1,000

I am seeing insistent claims that the investor is nevertheless allowed to deduct his $1000 loss once he has gone 30 days without owning any XYZ stock, but I cannot find any actual rule that says so.

Technically, it is 60 days (30 days before and 30 days after).

Answer 3

In the other Question chain which prompted this Question, you asked for a citation explaining the Wash Sale Rule. Here's one froma reliable source:

What is the 'Wash-Sale Rule'

The wash-sale rule is an Internal Revenue Service (IRS) regulation established to disallow a tax deduction for a security sold in a wash sale. The rule defines a wash sale as one that occurs when an individual sells or trades a security at a loss and, within 30 days before or after this sale, buys a “substantially identical” stock or security, or acquires a contract or option to do so. A wash sale also results if an individual sells a security, and the spouse or a company controlled by the individual buys a substantially equivalent security.

BREAKING DOWN 'Wash-Sale Rule'

The intent of the wash-sale rule is to prevent taxpayers from claiming artificial losses. Conversely, if a taxpayer were to see a gain by selling securities, and within 30 days he or she were to buy identical replacement securities, the proceeds from that transaction would still be taxable. The sale of options, which are quantified in the same ways as stocks, at a loss and reacquisition of identical options in the 30-day timeframe would also fall under the terms of the wash-sale rule. So the wash-sale period is actually 61 days, consisting of the 30 days before to 30 days after the date of sale.

For example, you buy 100 shares of XYZ tech stock on November 1 for $10,000. On December 15, the value of the 100 shares has declined to $7,000, so you sell the entire position to realize a capital loss of $3,000 for tax deduction purposes. On December 27 of the same year, you repurchase the 100 shares of XYZ tech stock back again to reestablish your position in the stock. The initial loss will be not be allowed since the security was repurchased within the limited time interval.

Wash-Sale Rule https://www.investopedia.com/terms/w/washsalerule.asp#ixzz5X9pg3C5F