A wash sale occurs when an investor sells a specific type of asset, such as a stock in a corporation, and then repurchases the same or substantially similar asset within 30 days. By creating a wash sale, the investor can only deduct the original capital losses once the investor completely exits the position.
For example, on October 1, 2021, Adam purchased 100 shares of stock at $30 per share for $3,000. On June 15, 2022, Adam sold all 100 shares for $25 per share for $2,500, which resulted in a $500 short-term capital loss. Ten days later, on June 25, 2022, Adam purchased 100 shares of the same company at $27 per share.
Adam created a wash sale by selling the shares for a loss on June 15, 2022, and purchasing the same security within 30 days. If Adam still holds the shares at the end of the tax year, the short-term capital loss of $500 will not be deductible. Adam must suspend the loss and can only deduct suspended losses when he completely disposes of the shares.
Not all investments are subject to the wash sale rules. For example, cryptocurrency transactions are not subject to wash sale limitations. The Internal Revenue Service (IRS) characterizes virtual currencies as property for U.S. federal tax purposes, so they are not securities for the wash sale rules. Taxpayers can use this exemption to their advantage with tax-loss harvesting. There is talk of changing the wash sale rules to include transactions with digital assets, but as of 2023, such changes have yet to be passed into law.