December is a popular time for most investors to review their investment portfolio to see how their year turned out. During this process, the investor might be encouraged to sell some of their investments by means of "capital gains harvesting". Capital gains harvesting in simplest terms is the process of selling investments positions with a gain and positions with a loss at the same time in order to generate cash with no tax impact. Investors will then take this cash and reinvest in other investments.
However, due to an intricate tax rule that is becoming more well known, there is a possibility that what the investor reinvests their cash in could result in the loss generated by the initial sale being disallowed. This is known as the "wash sale rule", and states that if an investor sells an investment at a loss and then purchases an identical investment within 30 days before or after the sale (60 days total), then the loss generated on the sale is disallowed and is added to the cost basis of the subsequent purchase.
For example, let's say I own 100 shares of ABC Inc and 100 shares of XYZ inc. In December, my ABC stock has a $100 gain, and my XYZ stock has a $100 loss. I decide to sell them both and generate cash, with a net capital gain of $0. This is great because I now have cash to reinvest and I have no tax impact. Then on January 3 of the following year, I hear on CNBC that XYZ has developed a new product that is going to make them much more profitable, so I go to my investment account and purchase 100 shares of XYZ again. Because I sold XYZ at a loss in December, and then repurchased an identical security within 30 days, my $100 loss generated in December is disallowed for tax purposes, and instead the $100 is added to the cost basis of the shares I purchased in January.
Fortunately, due to new reporting requirements for brokerages, wash sales will be automatically reported on a taxpayer's year-end Form 1099-B. Investors should watch their investment transactions closely during December and January and be aware of any sales that might be subject to the wash sale rule.
Additional information on sales of investments and wash sales can be found here at the IRS website.