Most people know that if you sell a security for a loss, you can use this loss to offset capital gains as well as up to $3,000 of ordinary income (only after you have no cap gains). However, the The Wash Sale Rule applies if you buy sustantially identical securities within 30 days. But of course, like most IRS regulations, the wash sale rule has some complications.
First, the wash sale period actually covers 61 days: the 30 days before the loss sale, the day of the sale, and the 30 days after the loss sale. Let’s sayyou’re thinking about selling stock “A” on March 31st. You cannot have bought any additional shares of the stock 30 days priors (March 1st) AND you cannot buy any more shares until 30 days after (April 1st).
Second, what are substantially identical stock? This one is trickier because of the ambiguious language. As a general rule, stock of one company is not substantially identical to stock of another company, even if they are both in the same industry. However, if you buy stock where the prices are linked to each other (like a company expected to merge with another), the regulations says these are substantially identical. Additionally, the wash sale rule may apply if you realize a loss from the sale of a put option you sell or allow to expire. Mutual funds managed by different firms are typically considered different, even if they are tracking a similar index or industry.
Third, new guidelines published in early 2008 applied the wash sale rule to your IRA accounts. Therefore, you can’t take the loss if you sell the stock in your taxable accounts and then buy them in your IRA or Roth IRA.
You won’t get flushed by the wash sale rule if you’re careful. Avoid buying replacement stock within the 61-day period. However, even if you misstep and get dinged with the wash sale rule, there is one saving grace. The amount of loss on the previously held stock can generally be added to the basis of the replacement stock.