If you accidentally perform a wash sale and claim the disallowed loss on your tax return, the Internal Revenue Service (IRS) will re-figure your taxes, disallowing the loss you claimed, and bill you for the difference.
Understanding the Impact of an Accidental Wash Sale
An accidental wash sale occurs when you sell an investment at a loss and then purchase a "substantially identical" investment within 30 days before or after the sale. Even if unintentional, claiming a loss from such a transaction is prohibited by IRS rules. The IRS closely monitors these transactions because your broker reports all investment activities directly to them.
Key Consequences of an Accidental Wash Sale
When the IRS identifies a wash sale loss that was incorrectly claimed, here's what typically happens:
- Tax Re-calculation: The IRS will adjust your tax return to disallow the loss you claimed from the wash sale. This means your taxable income will be higher than what you initially reported.
- Increased Tax Liability: With a higher taxable income, your overall tax liability will increase.
- IRS Bill for Difference: The IRS will send you a bill for the additional taxes you owe, plus any applicable interest and penalties on the underpayment. You will be required to pay this difference.
- Broker Reporting: Keep in mind that brokerage firms provide detailed transaction reports (like Form 1099-B) to the IRS, containing all the necessary figures to identify wash sales. This makes it straightforward for the IRS to spot these discrepancies.
The table below summarizes the direct consequences:
| Consequence | Explanation |
|---|---|
| Tax Re-calculation | The IRS will re-figure your taxable income by disallowing the improperly claimed loss. |
| Increased Tax Liability | You will owe more in taxes than you originally reported due to the disallowed loss. |
| IRS Bill for Difference | The IRS will send you a bill for the underpaid taxes you now owe. |
| Potential Penalties & Interest | If the error is not corrected promptly, you may face additional penalties and interest charges on the underpayment. |
| Broker Reporting | Your broker reports all trading activity to the IRS, making it easy for them to identify wash sales. |
What is a Wash Sale (Briefly)?
A wash sale occurs when you sell or trade stock or securities at a loss and, within 30 days before or after the sale, you:
- Buy substantially identical stock or securities.
- Acquire substantially identical stock or securities in a fully taxable trade.
- Acquire a contract or option to buy substantially identical stock or securities.
- Acquire substantially identical stock or securities for your individual retirement arrangement (IRA) or Roth IRA.
The intent of the wash sale rule is to prevent investors from claiming artificial tax losses by selling securities and immediately buying them back to maintain their investment position.
How to Mitigate or Avoid Issues
Even if accidental, taking steps to prevent or correct a wash sale can save you from future headaches.
- Track Your Trades Carefully: Maintain detailed records of your buys and sells, especially when dealing with investments at a loss. Note the dates of transactions and the specific securities involved.
- Understand the 30-Day Rule: Be mindful of the 30-day window before and after a loss-generating sale. Avoid repurchasing the same or substantially identical securities within this period if you intend to claim the loss.
- Utilize Brokerage Statements: Your brokerage statements and year-end tax forms (like Form 1099-B) will often highlight potential wash sales. Review these documents carefully.
- Consult a Tax Professional: If you're unsure whether a transaction constitutes a wash sale or how to report it, it's always best to consult with a qualified tax advisor. They can help you navigate complex tax rules and ensure compliance.
- Self-Correction: If you realize you accidentally claimed a wash sale loss, you can typically correct this by filing an amended tax return (Form 1040-X). This proactive approach can help you avoid or reduce potential penalties from the IRS.
By being informed and vigilant, you can navigate investment sales without falling foul of the wash sale rule, whether accidentally or intentionally.
