One of the most frequent questions I receive is "How do I deal with wash sales?" or "How can I eliminate the wash sales on my 1099-B and report the actual loss?"
The wash sale issue became more prevalent when brokers were mandated by Congress to start reporting cost basis to IRS and taxpayers back in 2008. Implementation for stock was January 1, 2011 and options January 1, 2013 with various iterations of compliance. Since then, it has been the bane of the Investor's or Trader in Securities' trading existence.
As explained on this website, a wash sale is created when a security, including an option to buy a security - long call or short put - is opened 30 days before or 30 days after the original security is sold for a loss. There can be no wash sale with gains.
For example, you decide to buy NVDA on 11/19/2024 for $145. On 12/31/2024 you sell NVDA for $135 creating a $10 loss per share. Then on 1/27/2025 you again repurchase NVDA at $120 hoping to take advantage of 4-month low. Since you experienced a loss on the transaction in 2024, you expect to be able to recognize that loss on your 2024 tax return.
However, not so fast ... You replaced NVDA on 1/27/2025 - less than 30 days from the loss sale on 12/31/2024 - creating a wash sale on 12/31/2024.
But wait, that is in a completely different tax year!! Yes it is but that is not how IRC Sec 1091 works. Regardless of the year, wash sales can stretch over a tax year-end because, in our example, 1/27/2025 is 27 days after the loss. If you had waited until 1/31/2025, you would have been home free, without a wash sale.
The reason for the wash sale rule is that IRS does not want an investor/trader to be able to receive a tax benefit from a loss and still participate in the potential gain.
In the age of rapid-fire trading and stock market volatility, this is a day-trader's worst nightmare, because they typically learn about wash sales when they receive their Form 1099-B in February, too late to do anything about it.
And, to add insult to injury, there is the $3000 net capital loss limitation, so even if a loss could be deducted, only $3000 can offset ordinary income and any remaining loss is carried over to subsequent years.
A mark-to-market trader, however, does not have to worry about wash sales or net capital loss limitations. But MTM is not a panacea because any gain is taxed as ordinary income.
If you are going to try to make a go of day-trading, strongly consider a mark-to-market election. With prudent planning, set aside the proceeds from gains to pay any income tax liability instead of experiencing wash sale losses and paying tax on artificial income.