The wash sale rule is a law preventing a person from repurchasing a stock that he or she has just sold or from purchasing a stock and then selling it right away. The wash sale rule was put into place in order to stop people from selling a stock that has performed poorly in order to deduct the loss from their taxes, then purchasing the stock again because they believe the value of the stock will rebound.
According to the wash sale rule, a person is in violation if he or she takes a loss on the sale of a stock and purchases the same stock thirty days after or before the sale. As a result, the wash sale rule time period actually lasts a total of 61 calendar days, the thirty days before the sale is made, the thirty days after the sale is made, and the day of the sale. Therefore, a stock sold on 31 March and purchased again on 10 April would be considered a wash sale. The entire month of March would also fall within the wash sale rule time period, because it consists of the thirty days before the sale.
In accordance with the wash sale rule, a person who sells and purchases the same stock within this 61 day period may not claim the loss from the sale of the stock. On the other hand, the loss may be added to the basis of the stock that was purchased to replace the original stock.
For example, if a person purchases a stock for 70 US dollars (USD) and sells it for 20 USD, he or she has a loss of 50 USD. If he or she purchases that stock again within the next 31 days for 23 USD, he or she can add the 50 USD loss to the purchase price. In this way, the stock is treated as if it was purchased for 73 USD. If the person sells the stock again for 80 USD, he or she only has to report a 7 USD gain. At the same time, if the person sells the stock again for the 23 USD that was paid the second time, he or she can still claim a loss of 50 USD.
Another consequence of the wash sale rule is that the holding period of the replacement stock is included with the holding period of the original stock that was sold. In other words, if a person holds a stock for over a year, sells it, and then buys it back within the wash sale period, the replacement stock counts as if it had also been held for over a year. Holding a stock for a short period of time is usually better for tax purposes than holding one for a long period of time. Therefore, the wash sale rule can be costly because of this part of the law.