The Wash Sale Rule: How to Harvest Losses Without Triggering the IRS Trap
The Wash Sale Rule: How to Harvest Losses Without Triggering the IRS Trap
CORE INSIGHTS
- The Trap: If you sell a stock for a loss and rebuy it (or a substantially identical one) within 30 days, you CANNOT claim the tax deduction. The loss is deferred. IRC § 1091
- The 61-Day Window: The danger zone is 30 days before the sale and 30 days after the sale. Automatic dividend reinvestment (DRIP) is the most common accidental trigger.
- The ETF Swap: The IRS allows you to swap to a “similar” but not “identical” asset. Selling VOO (S&P 500) and buying VTI (Total Market) is the gold standard for avoiding Wash Sales.
Tax-Loss Harvesting” is great, but only if you follow the rules. The Wash Sale Rule is designed to prevent you from claiming a tax break while essentially keeping your position. But there is a legal workaround.
What counts as a Wash Sale?
- Identical (Wash Sale): Selling VOO → Buying IVV. (Both track S&P 500).
- Similar (Safe): Selling VOO → Buying VTI. (S&P 500 vs Total Market). IRS Pub 550
- Strategy: Stay in the market, harvest the loss, but change the ticker.
What-If Scenario: Harvesting a $5,000 Loss
| Strategy | Action | Deductible Loss |
|---|---|---|
| Panic Sell & Rebuy | Sell TSLA, Buy TSLA (Day 15) | $0 (Disallowed) |
| ETF Swap | Sell SPY, Buy VTI (Day 0) | $5,000 (Allowed) |
Visualizing the Deduction Impact
*Figure 1: Tax Savings. The Red bar is $0 because the wash sale rule blocked the deduction. The Green bar is money in your pocket.*
Strategic Action Steps
Before harvesting losses, disable “Automatic Dividend Reinvestment” for that stock. If a dividend buys 0.1 shares within the window, it can trigger a partial wash sale.
For every asset, have a backup. S&P 500 ↔ Total Market. Developed Markets ↔ Total International. Coca-Cola ↔ Pepsi.
Do not sell in your Taxable Account and rebuy in your IRA/401(k) within 30 days. This is a “Permanent Wash Sale”—the loss is gone forever, not just deferred. Rev. Rul. 2008-5
The Bottom Line: Who Should Choose What?
- Do Swap: If you have >$3,000 in losses and can find a correlated partner asset.
- Wait 31 Days: If you must own the exact same stock (e.g., Tesla). Sit in cash for 31 days, then rebuy.
What is a Wash Sale?
Selling a security at a loss and buying a substantially identical one within 30 days (before or after). The IRS disallows the loss deduction.
What is ‘Substantially Identical’?
Funds tracking the exact same index (VOO vs IVV) are identical. Funds tracking different indices (VOO vs VTI) are generally considered safe partners.
Does this apply to IRAs?
Yes! Selling in a taxable account and rebuying in an IRA triggers a Wash Sale. Worse, the loss is permanently lost, not added to your IRA basis.