WHAT IS A WASH SALE?
A DEEP DIVE FOR ACTIVE TRADERS
A deeper explanation of wash sales, why they happen, and why every active trader should understand them.
When you first get into trading, wash sales probably aren’t even on your radar. You’re focused on one thing—making money. But once tax season rolls around and you receive your first 1099-B, you may quickly realize just how important wash sales really are—whether you like it or not. So, exactly what is a wash sale, and why does it matter to traders?
Keep reading, or watch our video to start understanding wash sales better.
What is a Wash Sale: Simple Explanation
A wash sale occurs when you sell a security at a loss and then repurchase the same—or a substantially identical—security within a short period of time.
Simple wash sale example:
- You sell 100 shares of TSLA today and take a $1,000 loss.
- The next week, you buy 100 shares of TSLA again at roughly the same price.
What happened? Effectively, the sale is a wash. You ended up with the same shares, at roughly the same cost, but you created a realized loss in your P&L.
Why Would Anyone Do This?
Some traders intentionally create wash sales as a way to harvest artificial losses and reduce or eliminate taxable capital gains.
Here’s how the strategy might look:
- You’ve made a $30,000 trading profit so far this year.
- Before year-end, you execute trades that generate $33,000 in losses, immediately buying back the same shares.
- You still hold the investment, but you’ve wiped out all taxable gains—and even created an extra $3,000 capital loss deduction, which is the annual maximum allowed by the IRS.
Sounds tempting, right?
Here’s the Problem: It’s Illegal
Harvesting wash sale losses to evade taxes is explicitly prohibited under U.S. tax law.
The IRS wash sale rule, introduced in the Revenue Act of 1921, was created for the sole purpose of preventing this form of tax manipulation.
And over the years, traders have tried many tactics to get around the rule, including:
- Buying replacement shares before selling at a loss
- Using a different brokerage account
- Using options or contracts that effectively replace the security
- Repurchasing inside a non-taxable IRA
In response, the wash sale rule has expanded to cover all these scenarios—and more. Today, it is one of the most complex regulations affecting active traders.
Why Wash Sales Matter for Modern Traders
Here’s the reality: Even if you’re not trying to harvest losses, you may still generate wash sales frequently—sometimes daily—just through normal active trading. Active traders can generate wash sales daily without even realizing it, due to frequent buying and selling of similar securities.
And whether they’re intentional or not, the IRS requires that all wash sales be identified and properly reported.
Failure to manage them can lead to:
- Incorrect cost basis
- Inflated gains
- Disallowed losses carried into the next year
- Potentially disastrous tax outcomes
That’s why understanding wash sales is essential for every active trader.
Key Takeaways
- A wash sale happens when you repurchase a security shortly after selling it at a loss.
- Wash sales can be used to artificially harvest losses—but the IRS specifically prohibits this.
- The wash sale rule is complex and covers many scenarios across accounts and security types.
- Active traders often create unintentional wash sales and must account for them properly when filing taxes.
Ready to learn more? Next, dive deeper into the IRS wash sale rule itself—what it says, how it applies, and what traders need to watch out for.
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.