A wash sale occurs when you sell a security at a loss and then buy the same security, or a substantially similar security, within 30 days before or after the sale. If you do this, the IRS disallows the loss for tax purposes.

Here is an example:

  1. You own 100 shares of XYZ company that you bought for $500.
  2. The value of XYZ stock drops, and you decide to sell the shares for $400.
  3. You realize a loss of $100 on the sale ($500 purchase price - $400 sale price).
  4. Within 30 days before or after the sale, you buy 100 shares of XYZ stock for $450.
  5. You are now in a wash sale because you sold XYZ stock at a loss and then bought the same security within 30 days.

In this case, the $100 loss would be disallowed for tax purposes. The $100 loss would not be lost permanently, however. It would be added to the cost basis of the new shares of XYZ stock that you purchased for $450. This means that your cost basis for the new shares would be $550 ($450 purchase price + $100 disallowed loss).

If you sell the new shares of XYZ stock at a later date for more than $550, you will realize a capital gain. If you sell the shares for less than $550, you will realize a capital loss. The capital loss can be used to offset capital gains in the current tax year or carried over to future tax years, subject to the capital loss carryover rules.

So within the life cycle of your position, the disallowed wash sale will be recovered. I encourage my client to have a long term view of life, but not let your mode carried up and down by the market.