You are not allowed to claim a capital loss if you sell a stock and immediately buy it back.
How would someone benefit from this if it were allowed? For example:
If I buy a stock for $100, goes down to $80 then goes up to $120, and sell for $120, that’s a $20 capital gain.
If I buy a stock for $100, goes down to $80, sell for $80 and buy it back, and then later sell for $120, that’s a $40 capital gain minus the $20 loss = $20 capital gain.
In both cases it came out the same. I don’t see how someone could benefit from it and why it’s not allowed.
Edit: Clarified first example that it goes down to $80 then up to $120.
Comments
Because you’ve creating fake trading volume that outsiders wouldn’t know is false, making your stock look more popular and potentially attractive than it truly is.
Because the government doesn’t want you taking a capital loss without actually leaving the investment. Otherwise, it’s not really a loss.
You kinda answered your own question. You’ve recorded a $20 capital gain even though your investment went from $80 to $120.
There’s a difference in tax rates for short term vs long term gains. it’s so you can’t claim a loss at short-term rates, then immediately buy back the stock for a long-term gain.
Now do what happens if you die before you realize the capital gains.
You’re allowed to kick the can down the road by not realizing gains, but the IRS limits just how far down the road you’re allowed to kick the can. That’s pretty much it.
You benefit if there’s something else going on. Example:
Earlier in the year, you sold some stock, for a big capital gain. That’s going to be taxable.
Now, at the end of the year, you sell a different stock, at a loss, and buy it right back. If it was not for the wash sale prohibition, you’d be able to use that loss to offset the gain earlier in the year, and avoid the tax hit.
Timeframing and taxes. Let’s say it’s December 28th 2023. I’ve had 20k in short term capital gains. I have a position that is a bit of a dog right now but I believe in the position. I sell that position for a 20k loss. Now I have no capital gains and thus owe no tax. I buy back the position. hold it a year, its now Dec 29 2024, and was right about it. I sell it for a 40k gain from that loss. Now I pay taxes on 40k in long term gains at a lower rate. Or I could sell a dog position, and buy it back, kicking the can down the street.
I believe that’s the essence as to why it’s a problem. It has to do with dodging tax
It’s to prevent loss harvesting to lower tax obligation. It’s about selling at a $20 loss today to lower taxes this year, buying back because you still want to hold stock long term.
Taxes. Bought for $100, sold for $80. You can reduce your taxable income by the amount of the loss (up to $3000) and / or offset realized capital gains on a different investment. Either way reduces your tax liability in the current tax year. If you sell for $120 in the same tax year there’s really no advantage, but (if it were allowed) people would take the loss right at the end of a tax year, and push the eventual realized gain into a later tax year.
A lot of incorrect info in the replies.
The answer is that the government doesn’t want you to be able to claim losses right away if you aren’t leaving the investment.
If you get a capital loss you can use it to lower your taxes right now. Yes you end up paying higher gains later* and offsetting the loss, but the government doesn’t want to give you a free loan until then.
So they disallow generating losses ‘on paper’ without actually leaving the investment.
If they didnt disallow this someone could get free loans (essentially) from the government.
I buy a thousand stocks for $100; after a while, it is now worth $80. I sell at $80, then immediately repurchase, but hold, not sell.
If wash trading was allowed, I would be able to report to the government I had a $20,000 loss that year, reducing my tax burden.
Then, I can hold the stock until much later when something else makes my tax burden lower anyway, so the extra 20k of gained capital doesn’t matter as much
It’s about taxes. Imagine you have a stock which has dropped 5% over the last year, and another which has gained 5%. You could sell both, claim the Capitol loss deduction, and buy it back immediately, which then offsets the capital gains from the stock you sold. If you immediately buy back the losing stock, then you effectively just cashed out a gain without paying taxes on it.
If there were no wash sale rule, you would be able to claim fabricated losses against your taxes without actually losing anything.
In your first example, you would have to pay taxes on your $20 gains.
In your second example, if you recorded a $20 loss when you sold at $80 and bought it back a second later, then you could claim it against your $20 gain at $120. You would pay no taxes because you told the IRS you broke even when you actually gained $20.
Also, I should add it’s not so much that wash trading is not allowed: you can still buy and sell a stock in close succession as much as you want. It’s just that any losses recorded as a result of wash trading can’t be claimed on your taxes.
You might not fully understand a wash sale
Once you sell the stock and do not re buy for 30 days; the wash sale does not matter. The profit or loss is the true profit and loss
During a calendar year , if you buy , sell , re-buy , sell (final) it 100% does not matter, your taxes will not be different
Lets say in November 2024 I buy stock ABC for $100
In Dec 20th 2024 I sell for 80
On Jan 2 I buy stock ABC back for $80.
So now all a wash sale is saying is “For 2024 you cannot claim that $20 loss “
There’s a saying, taxes delayed are taxes saved.
If you can push a tax into some future year, that’s often “good enough” for a lot of tax planning to work out.
So you have a $50 capital gain this year. You also own some stocks that are currently in a loss position, but you intend to hold them long term.
You sell those stocks, crystalize the loss, then immediately buy them back. This allows you to offset your gain with a loss, so no taxes paid this year. You have successfully shifted that tax payment out of today and into some vaguely defined future date, yay!
Now you are kind of correct, it’s not a true savings. Except if you hold those stocks until you die. If you hold them until you die then they get a FMV bump up and you owe no gains at all.
So it’s both a “prevent paying this gain until later” and a “I might die before i sell them” situation.
Today I learned that you’re not allowed to crystallise losses in the US.
That’s the term I’d google for an explanation, “crystallising losses”
Lot of good answers here about losses but also stocks are fungible, if you sell a stock and immediately buy it back did you actually sell it? So to prevent tricky business the government effectively makes you ignore the sale and repurchase (or purchase and sale) if it’s within (generally) 30 days.
A lot of decent replies, but they’re short on examples. Here’s an example of how wash selling, if it was allowed, would benefit the trader.
You buy 1000 shares in a stock at $100/share on Jan 1, $100k investment
On Mar 1 the price goes up to $120/share and you sell for $120k, you now have $20k of capital gains and no shares. Let’s say your tax rate is 40%, that means you are going to owe $8k in tax on that $20k in gains.
On May 1, the price has fallen to $80/share. You’re a smart investor, you know you shouldn’t reinvest your tax burden because it could cause a problem for you when taxes are due, so you only put $112k in (1400 shares), you keep that $8k in the bank because you don’t want to gamble with your tax burden.
On July 1, the price has fallen further, to $40/share. Your 1400 shares are now only worth $56k, but you still have that $8k sitting in the bank to cover your taxes! You sell and then immediately re-buy 500 of your 1400 shares. Since you bought them at $80/share and sold them at $40/share, you “lost” $40/share, *500 shares means on paper you generated a $20k CG loss. This cancels out your $20k CG gain from earlier in the year, you now have no tax burden for the year! You then take that $8k you had set aside and dump it into the stock as well, buying another 200 shares. You are now fully invested and own 1600 shares, 700 of those shares have a cost basis of $40, 900 shares have a cost basis of $80. With no gains or losses on the books for the year, you pay nothing in taxes (yet).
2 years later the share price has gone up to a whopping $200/share, and you decide to sell everything. 1600 shares means you pocket $320k, and your capital gains are 700*(200-40)+900*(200-80) = $220k. At 40% tax rate you owe $88k and walk away with $232k total
Now how does that compare to the case without wash selling?
Steps 1-3 are identical
On July 1, the price has fallen further, to $40/share. But you can’t wash sell, and you don’t have any additional money, so you can’t do anything but watch. At the end of the year you pay your $8k tax burden and are still sitting on your 1400 shares.
2 years later the share price has gone up to a whopping $200/share, and you decide to sell everything. 1400 shares means you pocket $280k, and your capital gains are 1400*(200-80) = $168k. At 40% tax rate you owe $67.2k and walk away with $212.8k total. $19.2k less than if you were allowed to wash-sell those shares and reinvest the $8k you had set aside instead of giving it to the government early on.
Why is it not allowed? Because the government wants their money now, not later.
You can buy a similar but different stock. It works best for index etfs, harvest the loss on SPY and buy IVV.
So many if these comments miss the point:
99.999999% of the sales you make that get reported as wash sales are NOT really wash sales and are still deductible. If you leave it up to the brokerage to report it YOU ARE LOSING MONEY on your taxes. It’s sooooo important to learn this.
Brokerages list anything where you sold a security for a loss and re-bought within 30 days as a wash sale. THEY ARE NOT. A wash sale is when you sell a stock for a loss, in the hopes of reducing your tax base with the loss, then immediately turn around and buy it back.
That’s it. If you sell the stock yet again before the end of the year and this time you do not buy it back, then NONE of those ‘wash sales’ listed by your brokerage are actually wash sales. List the wash sale reduction as $0 on your taxes no matter WHAT your tax documents claim.
Brokerages are overly careful and people are too lazy to actually read the tax laws, and so ya’ll lose money every year because you don’t manually fix what the brokerage reported to you.
Edit –
Example: It is April. I own 30 shares of NKE. I’m currently in the red. I sell 20 shares at a loss. Within 30 days I buy 20 shares back again, because it’s dropped lower and I think it might rebound now. This gets reported on your taxes as a ‘wash sale’.
Now let’s say I waited 6 months and the rebound never happened. It’s October and I sell my NKE at a loss. (Again.) You have to do basic math to look at the both sales (April and October) to decide what your actual loss is. And that’s all deductible, because it wasn’t really a wash sale now. Your brokerage will report it incorrectly to the IRS and it’s up to you to manually fix this.
Day traders who sell all their short term stock holdings at Thanksgiving and go on vacation until New Years Day have no wash sales, no matter what the brokerages tell the IRS.