How Wash Sales
Affect Active Traders
The hidden tax costs and two situations every trader must watch for.
Understanding how wash sales affect active traders is essential, because the tax impact isn’t always obvious from your trading results. A trader can lose money during the year and still owe taxes due to wash sale adjustments—sometimes even reporting a gain on their Form 1099-B despite having a net loss. Let’s look at how this happens and what every trader should watch for.
Most new traders know losses are part of the learning curve. But what happens when you lose money — and still owe taxes on profits you never made?
That’s exactly what happened to Vanessa. During her first year actively trading, she realized $66,000 in net losses. Yet when tax forms arrived, her broker reported a taxable gain of $166,000 because of wash sale adjustments.
She lost money, but owed taxes as if she’d made a sizable profit.
How can that happen? And could it happen to you?
Can You Avoid Wash Sales?
Traders often ask: “How do I avoid wash sales?” There are two possible solutions:
1. Elect Section 475(f) Trader Tax Status
If you legally qualify for Trader Tax Status (TTS) and file an election under IRS Section 475(f), you’ll use mark-to-market accounting. Wash sale rules no longer apply.
However:
- Not every trader qualifies
- The election carries other tax consequences
- It must be filed on time
This option is powerful but isn’t right for everyone.
2. Never Have a Loss (We Wish!)
It sounds unrealistic, but this principle matters:
Profitable traders experience fewer harmful wash sales.
If your trades are net profitable, wash sale adjustments are more likely to be absorbed into your gains without long-term consequences. The wash sale still exists and must be reported correctly, but it doesn’t harm your taxable outcome.
So yes — making more winning trades is actually part of wash sale management and should be the top priority of every trader.
Why Wash Sales Are Like Icebergs
During the year, traders often think they know their gains and losses. But wash sale adjustments can accumulate below the surface — without you noticing until tax time.
You may only see the full impact after the year ends, when your Form 1099-B arrives. By then, it’s usually too late to change course. The consequences may sink you financially.
That’s why it’s critical to pay attention to wash sales before the tax year closes, and to understand where the dangers lie.
Two Situations Where Wash Sales Can Be Disastrous
Let’s focus on the two most harmful situations traders need to be aware of to avoid wash sale disasters.
#1 – IRA Wash Sales (Always Harmful)
If you sell a security at a loss in your taxable account and then buy a substantially identical security in your IRA within the wash sale window, the IRS considers it a wash sale.
But here’s the problem:
- The loss in your taxable account is disallowed
- No cost basis adjustment is made in the IRA
- The loss is gone forever
You lose the deduction permanently. You can’t recover it later.
REAL EXAMPLE: Marty
Marty was a successful trader who made nearly $2.9 million in taxable gains. But he actively traded the same securities in both his taxable account and his IRA — unaware of IRA wash sale consequences.
The result? He permanently lost $900,000 in taxable losses, increasing his taxable gains to $3.8 million.
And you might wonder: “How would the IRS know? IRA trades aren’t reported on a 1099.”
Because regulations require taxpayers to make these adjustments themselves, and in an audit the IRS can demand IRA records.
This is exactly why traders use TradeLog — it tracks trades across taxable and non-taxable accounts and flags IRA wash sale risks before they happen.
#2 – Year-End Wash Sale Deferrals (Upside-Down Taxes)
Wash sales that accumulate through the year can snowball and defer losses into the next tax year. This can:
- Inflate taxable gains in the current year
- Make profitable traders owe more taxes
- Make losing traders owe tax even when they lost money
Even profitable traders can face inflated taxable gains from year-end wash sale adjustments.
REAL EXAMPLE: Vanessa
Remember Vanessa? She realized $66,000 in losses, yet her broker reported $166,000 in taxable gains because of:
- $232,000 in wash sale adjustments snowballed through the year
- She acquired shares in January of the next year, triggering a year-end deferral.
She was upside down — paying taxes on money she never made.
What Traders Should Focus On
If learning about wash sales makes you worry, that’s normal. Some traders become obsessed and try to avoid every wash sale — but that can distract from what matters most:
👉 Profitable trading reduces wash sale harm.
Managing wash sales is important, but profitable trades do more to protect you than trying to avoid every loss-triggered adjustment.
The Good News: You Can Take Control
Traders can mitigate harmful wash sale consequences by:
- Monitoring IRA and taxable account overlap
- Tracking wash sale buildup before year-end
- Reviewing December and January trading activity carefully
- Using software designed to make IRS-compliant adjustments (like TradeLog)
You don’t have to worry all year. The biggest impact opportunities generally happen in a relatively small window at year-end.
Key Takeaways
- Wash sales can inflate tax liability, even causing you to owe taxes when you lost money.
- Section 475(f) is the only true way to eliminate wash sales.
- IRA wash sales permanently erase losses.
- Year-end wash sale deferrals could cause problems.
- Tracking tools help take control of wash sale impacts.
What’s Next?
Next up, we’ll show you how to track, analyze, and control wash sales before they cost you money.
Learn More
Go to our WASH SALES Comprehensive Guide
Visit our TRADER TAXES Education Center
Learn how TradeLog helps traders and active investors take control of wash sales.
Please note: This information is provided only as a general guide and is not to be taken as official IRS instructions. Cogenta Computing, Inc. does not make investment recommendations nor provide financial, tax or legal advice. You are solely responsible for your investment and tax reporting decisions. Please consult your tax advisor or accountant to discuss your specific situation.