Understand the IRS Wash-Sale Rule when Day Trading - dummies (2024)

FAQs

How does the wash sale rule apply to day traders? ›

Q: How does the wash sale rule work? If you sell a security at a loss and buy the same or a substantially identical security within 30 calendar days before or after the sale, you won't be able to take a loss for that security on your current-year tax return.

A wash sale occurs when an investor sells a security at a loss and then purchases the same or a substantially similar security within 30 days, before or after the transaction. This rule is designed to prevent investors from claiming capital losses as tax deductions if they re-enter a similar position too quickly.

Keep in mind that the wash sale rule goes into effect 30 days before and after the sale, so you have a 61-day window to avoid buying the same stock.

You must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation; Your activity must be substantial; and. You must carry on the activity with continuity and regularity.

Example of a Wash Trade

Let's say, for example, that an investor owns 50 shares of Company ABC and sells the shares on January 1 at a loss of $2,000. The investor then buys 50 shares in the same company on January 22 and subsequently realizes a gain of $4,000. A wash trade hasn't technically occurred yet.

Capital gains distributions and dividend distributions—the money you make on your investments—require you to pay taxes in the year you take these distributions. Investors may avoid or defer these taxes by holding their investments in a tax-advantaged account, like a 401k or IRA.

To avoid triggering the wash sale rule, an investor can employ a strategy such as buying more of the stock that they'd like to sell, holding on to the new stock purchase for 31 days, and then selling it. An investor could also sell a stock at a loss, register the loss, and then buy a similar investment.

Note: Wash sales are in scope only if reported on Form 1099-B or on a brokerage or mutual fund statement. Click here for an explanation. A wash sale is the sale of securities at a loss and the acquisition of same (substantially identical) securities within 30 days of sale date (before or after).

However, if you violate the wash sale rule, any loss from the sale of stock or securities is disallowed for tax purposes and can't be deducted from your capital gains or ordinary income. A disallowed loss is not completely wasted, though.

Can you buy and sell a stock on the same day? Retail investors can buy and sell stock on the same day—as long as they don't break FINRA's PDT rule, adopted to discourage excessive trading.

Why are capital losses limited to $3,000? ›

The $3,000 loss limit is the amount that can be offset against ordinary income. Above $3,000 is where things can get complicated. The $3,000 loss limit rule can be found in IRC Section 1211(b). For investors with more than $3,000 in capital losses, the remaining amount can't be used toward the current tax year.

Designed to prevent abuse, it disallows tax deductions if you repurchase similar securities within 30 days. To maintain tax benefits, refrain from purchasing identical securities 30 days before or after a sale or adjust by selling again later.

Trader tax status also allows day traders to make an election for something called mark to market. A day trader who does not have trader tax status can only write off up to $3,000 in trading losses when they file taxes, but those with mark to market election can claim greater losses, if applicable.

As a trader (including day traders), you report all of your transactions on Form 8949 Sales and Other Dispositions of Capital Assets.

As a day trader, you benefit from being self-sufficient: scheduling meetings with a mentor you can learn from, or making office supply runs to ensure you have what you need to do your job well. If you drive for these or other work-related purposes, you can claim car expenses on your taxes.

One strategy for avoiding wash sales in options trading is to trade different expiration dates or strike prices. For example, if an investor sells a call option and then buys a put option with the same expiration date and strike price, this would likely trigger a wash sale.

Technically, you have to wait before you buy the stocks you sold for losses back. The wash rule claims that, in case you sell any investment at a loss, and then you re-buy it within a month (30 days), the loss that you made initially cannot be accounted for the purpose of taxation.