Wash: Meaning, Operation, Legality

What Is a Wash?

A wash is a series of transactions resulting in a net sum gain of zero. An investor can lose $100 on one investment and gain $100 in another. That’s a wash. However, the tax implications can be complex.

A wash is also known as a break-even proposition.

Key Takeaways

• In investing, a wash is a loss canceled out by an equal gain.
• For tax purposes, a wash is an investment loss that can be deducted.
• Time restraints exist on an investor’s ability to deduct the loss if the same stock is repurchased.

Understanding a Wash

When it’s a wash, two transactions cancel each other out, creating a break-even position.

If a company spends $25,000 to produce merchandise and sells it for $25,000, that’s a wash. If an investor loses $5,000 on the sale of an investment and gains $5,000 from the sale of another, the transaction has been washed.

However, the IRS has intricate tax rules concerning wash sales by investors, especially regarding claiming losses on investments. These rules prevent an investor from claiming a loss if they sell a security at a loss and repurchase the same security or a similar one within 30 days.

For instance, suppose an investor buys 100 shares of Anheuser-Busch (BUD) stock for $10,000. Just six weeks later, the value of those shares declines to $7,000. The investor sells all 100 shares hoping to deduct the capital loss of $3,000 at tax time but then, a week later, decides to repurchase 100 shares of BUD.

The initial loss cannot be claimed for tax purposes since the same security was repurchased within the limited time interval.

An investor cannot sell a stock at a loss, repurchase the same stock within 30 days, and still claim the loss as a deduction.

However, the loss from a wash is not entirely wasted. The loss can be applied to the cost basis of the second BUD purchase. This increases the cost basis of the purchased securities and reduces future taxable gains when the stock is sold. The benefit of the wash has been delayed but not lost.

Moreover, the holding period of the wash securities adds to the holding period of the replacement securities. In this example, the investor has added six weeks to the holding period of the stock, making it easier to qualify for the most favorable tax rate on long-term capital gains. (Stock must be held for one year to qualify for that lower tax rate.)

Illegal Wash Sales

Some wash sales are illegal as they resemble a pump and dump scheme.

For instance, an investor cannot buy a stock using one brokerage firm and then sell it through another firm to generate investor interest.