Wash-sale rule

Definition

The wash-sale rule (IRC §1091; IRS Pub 550) DEFERS a realized loss for tax purposes when the same or a “substantially identical” security is acquired within 30 days BEFORE or AFTER the loss sale — a 61-day window. The disallowed loss is added to the replacement position’s cost basis (deferred, not destroyed — except in one notorious IRA case). Facts, never advice: active strategies that re-enter positions routinely trigger it, so the engine tracks the window mechanically.

How it works / structure

• The trigger mechanics (engine-executable): loss sale
  • acquisition of substantially identical securities within ±30 days = disallowed loss; the replacement’s basis absorbs the loss and its holding period tacks — the tax benefit moves to the future sale. Partial repurchases disallow proportionally; the rule matches lot-by-lot.
• “Substantially identical” (the judgment boundary): the same stock or options ON the same stock qualify (buying a call within the window of a stock loss triggers it — Pub 550 is explicit); different companies do not; similar-but-different ETFs (two S&P 500 funds from different issuers) sit in undefined territory the IRS has not ruled on precisely — the platform flags, tracks both interpretations, and never asserts the aggressive one.
• The traps with teeth: replacement INSIDE an IRA permanently destroys the loss (Rev. Rul. 2008-5 — no basis anywhere to absorb it); cross-account matching applies (spouse accounts included); year-boundary washes (December loss, January repurchase) defer losses across tax years; short-sale and options-assignment interactions compound the matching (acct-assignment-tax).
• The exemption: §1256 contracts (futures, broad-based index options) are mark-to-market and outside the rule (acct-section-1256) — one documented structural reason active strategies live in futures.

When it applies

Every taxable account running re-entry strategies (stop-outs with re-entries — mgmt-stop-loss cadences collide with the window; rebalancing sells — port-rebalancing); December loss-harvesting mechanics (the disposition effect’s annual inversion — bias-disposition-effect); options books on names with stock losses (the cross-instrument trigger). The engine computes windows; humans and agents receive flags, not advice.

Risk profile & failure modes

• Silent basis migration: unnoticed washes reshape after-tax results away from reported P&L — replay-vs-tax divergence the accounting layer must reconcile.
• The IRA destruction case: the one configuration where the loss is gone forever — flagged at maximum severity.
• Aggressive-substitution audits: “identical exposure, different ticker” harvesting strategies carry undefined- boundary risk — the platform labels the uncertainty rather than resolving it.
• Strategy-cadence collisions: any system that re-enters within 30 days converts every losing exit into a wash — after-tax replay differs from pre-tax replay by construction; both are computed.

Evidence & limits

The statute and Pub 550 are primary sources (cited); Rev. Rul. 2008-5 covers the IRA case. The substantially- identical boundary for similar ETFs is genuinely unsettled — stated as such. Nothing here is tax advice; the platform computes mechanical flags and defers judgment calls to the user’s tax professional by design.

Falsifiable-thesis examples

Illustrations only, not signals:

• “This strategy’s replay generates wash-sale flags on more than 20% of its losing exits (cadence-collision audit)” — falsified by the flag count.
• “After-tax replay (wash-adjusted) trails pre-tax replay by more than 1% annualized for this account (divergence measurement)” — falsified by the paired accounting.

Cross-references

• The options/assignment interactions: acct-assignment-tax
• The exemption zone: acct-section-1256
• The account-boundary facts: acct-account-types (IRA case)
• The colliding behaviors: mgmt-stop-loss (re-entries), port-rebalancing, bias-disposition-effect (December harvesting)