If you sell an asset at a loss, you might be entitled to either claim the loss as a deduction or use it to offset eligible gains. However, the wash sale rule sometimes comes into play, and it can be particularly pesky for those with multiple types of equity compensation from the same company (say, when you have those pre-IPO ISOs, there are RSUs vesting, and you also participate in the ESPP).
What Is the “Wash Sale” Rule?
When you sell an asset at a loss and acquire a “substantially identical” asset 30 days before or after that sale, the recognition of that loss is “postponed” until you dispose of the replacement asset. Instead of being deducted, the loss reduces the cost basis of the replacement asset. That is the wash sale rule in a nutshell, designed to prevent generation of losses while effectively holding on to the same assets. Generally, if you sell a stock at a loss and rebuy it the next day, the loss will be disallowed and postponed.
Here is an example: you received $200 for a sale of a share of META stock that originally cost you $350, generating a loss of $150. Within 30 days you acquired another share of META for $230. The $150 loss from the sale is not allowed to be claimed, but instead is added to the basis of the $230 share, increasing that basis to $380. When you sell that share later on for $300, you will report a loss of $80 ($380 - $300) instead of a gain of $70 ($300 - $230), as long as you don’t run into another wash sale disallowance.
What about Tax Loss Harvesting?
Tax loss harvesting is a strategy to collect realized losses without violating the wash sale rule. Most often it is accomplished by selling loss-generating securities, and then repurchasing similar but not identical ones, or waiting for 31 days before repurchasing the exact same holding. An example of a “similar but not identical” move would be selling Vanguard 500 Index Fund and buying Vanguard Total Stock Market ETF.
Does the Wash Sale Rule Apply to Shares Related to Equity Compensation?
Yes. If you sell your company’s stock at a loss and exercise (purchase) options, receive vested RSUs, or if ESPP shares get purchased on your behalf 30 days before or after the sale, the loss for the number of “replaced” shares will be shifted to the new replacement shares as an increase in basis and not claimed as a loss.
The wash sale applies to all of your assets across the board, including all brokerage and some retirement accounts, including accounts of related parties. Selling an asset at a loss and replacing that asset within 30 days in a different account would still result in a wash sale loss disallowance. Whether the investment custodians (Schwab, TD Ameritrade, Fidelity, etc.) pick up on it and report it as such is a whole other issue.
How Do I Avoid Wash Sales if I Receive Equity Compensation?
Before selling any loss-generating stock, consider when your shares vest, when ESPP shares get purchased, and the timing of ISO or NSO exercises.
Since the wash sale rule is not a total disallowance but a timing difference (you can capture that disallowed loss when selling the replacement asset), consider the entire picture of stock pricing, trading windows, your other capital gains and losses, etc. instead of exclusively chasing maximization of allowed losses.
Disposition of ISO Shares and the Wash Sale Rule
The wash sale rule usually applies to loss-generating sales of assets and to all sales of shares that were obtained through ISOs exercises during the same calendar year. For example, if you sold RSU or ESPP shares at a gain and replaced them, the wash sale rule does not apply since there is no loss. However, if you are trying to sell newly exercised ISOs before the end of the calendar year to avoid paying the associated AMT, any replacement acquisition might disallow the benefits of such disposition even if there is no de-facto loss.
Tracking losses for compliance with the wash sale rule can be very difficult, especially if you have accounts with multiple custodians and/or separate accounts with your spouse. Planning around a significant disposition should involve your tax or financial advisor, especially when the disposition might result in a generation of a loss.