Wash Sale Rules
IRS rules that disallow a tax deduction for a capital loss on a security if a substantially identical security is purchased within 30 days before or after the sale.
What Are Wash Sale Rules?
The wash sale rule, codified in IRC Section 1091, prevents taxpayers from claiming a tax deduction on a capital loss if they purchase a "substantially identical" security within a 61-day window — 30 days before the sale, the day of the sale, and 30 days after the sale. The purpose of the rule is to prevent investors from selling an asset at a loss to harvest the tax deduction and then immediately buying it back to maintain their investment position.
For startup employees, wash sale rules become relevant when selling company stock at a loss and then acquiring more shares through option exercises, RSU vesting, or open market purchases within the wash sale window.
How Wash Sale Rules Work
The 61-Day Window
The wash sale rule applies if you sell a security at a loss and then acquire a substantially identical security within 30 days before or 30 days after the sale date. "Substantially identical" generally means the same company's stock. The rule does not just look forward — buying replacement shares before the loss sale also triggers the wash sale.
The Disallowed Loss
When a wash sale occurs, the capital loss is not eliminated — it is deferred. The disallowed loss is added to the cost basis of the replacement shares. This means you will eventually recognize the loss when you sell the replacement shares (assuming you do not trigger another wash sale at that point).
Example: You sell 1,000 shares of company stock at a $10,000 loss. Within 30 days, you exercise options to acquire 1,000 new shares of the same company's stock. The $10,000 loss is disallowed and added to the cost basis of the newly acquired shares.
What Triggers a Wash Sale
Several equity compensation events can trigger a wash sale:
- Exercising stock options within 30 days of selling shares at a loss
- RSU vesting that delivers shares within 30 days of a loss sale
- ESPP purchases within the wash sale window
- Buying shares on the open market (for public companies) within the window
- Buying options or contracts on the same security within the window
What Does Not Trigger a Wash Sale
- Selling at a gain (wash sales only apply to losses)
- Buying a different company's stock
- Waiting more than 30 days before acquiring replacement shares
- Some tax advisors argue that exercising unvested options is not a purchase for wash sale purposes, but this area is unsettled
Practical Implications for Startup Employees
Option Exercises and Wash Sales
If you sell company shares at a loss and then exercise stock options within 30 days, you may trigger a wash sale. This is a common trap for employees who are managing their equity positions actively. The loss deduction you expected to offset other gains may be disallowed and shifted to the newly exercised shares' cost basis.
RSU Vesting Traps
For employees with RSUs that vest on a regular schedule (e.g., quarterly), selling shares at a loss within 30 days of a vesting date can trigger a wash sale if the vesting delivers new shares. Since RSU vesting dates are often fixed and automatic, this requires careful calendar management.
Impact on Tax Planning
A disallowed wash sale loss does not disappear — it increases the cost basis of the replacement shares. If you eventually sell the replacement shares more than 30 days later without repurchasing, you realize the deferred loss at that point. The net economic effect is a delay in recognizing the loss, not a permanent loss of the deduction.
Record-Keeping Requirements
Your broker may report wash sales on your 1099-B, but they may not catch all instances — especially when the purchase occurs through equity compensation events like option exercises or RSU vests through a different account. You are responsible for tracking and reporting wash sales accurately on your tax return.
How It Relates to Exercising Stock Options
If you hold company shares that are currently at a loss and are considering selling them for tax loss harvesting, check whether any option exercises, RSU vests, or other share acquisitions are scheduled within the 30-day window. If so, you may need to delay the sale or the exercise to avoid triggering a wash sale. Coordinate your exercise timing with your broader tax planning to ensure that capital losses are not inadvertently disallowed.