Understanding the wash sale rule in options can save you from unexpected tax headaches. Does wash sale apply to options like calls and puts? What are the key tax implications, and how can you avoid wash sale issues? This guide tells you more about what traders need to know on wash sale options and strategies to stay compliant.
Key takeaways
- The wash sale rule in options is a tax regulation that disallows claiming losses on sales of securities if you repurchase substantially identical securities within 30 days.
- This rule applies to both call and put options, as well as other asset classes like stocks and ETFs.
- To avoid wash sales on options, traders can wait 30 days, adjust strike prices or expirations, or trade similar but not identical securities.
What Is the Wash Sale Rule?
The wash sale rule in options is a tax regulation designed to prevent investors from claiming tax losses unfairly. If you sell an investment at a loss and buy the same or “substantially identical” asset within 30 days before or after the sale, the IRS disallows the tax deduction.
Here’s how it works:
- Assets it applies to: This rule impacts stocks, mutual funds, ETFs, and yes, even options.
- “Substantially identical” ambiguity: The IRS does not clearly define what qualifies as substantially identical, making compliance tricky for traders.
- Special scenarios: Selling at a loss in a taxable account and buying back the investment in a tax-advantaged account, like an IRA, still triggers the rule. Transactions between spouses may also count.
Please note that this guide isn’t tax advice—consult a tax professional to fully understand how to avoid wash sales on options and stay compliant.
How Does Wash Sale Apply to Options?
We told you what it is, but does wash sale apply to options? Yes, it does. While every case may be different, as the IRS rules can sometimes be hard to interpret, the basic principles are clear. Both call and put options fall under these rules, and understanding how to stay compliant is key for traders. Here’s how it applies:
Wash Sales in Call Options
- Selling a call option at a loss and then repurchasing a call with the same strike price and expiration date within 30 days triggers a wash sale. This is because the replacement option is considered “substantially identical.”
- If you choose to roll a losing call option position—for example, selling one option and immediately opening another with a similar strike or expiration—it could also be classified as a wash sale. The IRS may view this as repurchasing a nearly identical security.
Wash Sales in Put Options
- Selling a put at a loss and entering a new put contract with nearly identical terms (same strike and expiration) within 30 days creates a wash sale.
- Another common situation arises when you close a losing put trade and use the proceeds to buy the underlying stock during the restricted timeframe. The IRS could rule this as a wash sale because the stock and put are closely related.
Examples of Common Violations
The wash sale rule in options can create confusion, as even slight differences in contracts don’t always avoid problems. Here are some common mistakes:
- Selling a losing call or put and then writing a new contract that has only a minor difference in strike price or expiration. For example, selling a $110 call expiring in two weeks and writing a $115 call for the same timeframe could lead to trouble.
- While selling a put and then purchasing the underlying stock might be similar, the IRS does not typically classify this as a wash sale unless the put was deep in-the-money and served as a synthetic position replacement
Are There Best Practices to Avoid Wash Sales on Options?
Absolutely, and knowing how to avoid wash sales on options is tricky but manageable with some planning. Consider waiting at least 31 days before re-entering a similar position or adjusting the strike price or expiration significantly to avoid being classified as “substantially identical.”
These rules can get complicated, and the IRS’s interpretation isn’t always clear. If you’re in doubt, consulting a tax professional is the safest way to stay compliant and avoid unexpected tax surprises. Always document your trades thoroughly to back up your positions in case of an audit.
In any case, the next section will tell you more about the common practices and trading strategies to avoid wash-sale problems. We’d like to clarify that this is perfectly legal, as you are simply following the rules (but again, a check with your own tax advisor is always a good idea).
How to Avoid Wash Sales on Options
Avoiding the wash sale rule in options can be straightforward with the right strategies. Here is a table with some practical tips to help prevent wash sales in options:
| Strategy | How to Avoid Wash Sales on Options? | Key Benefit |
| Wait 30 Days | Avoid repurchasing the same or substantially identical option within 30 days. | Ensures compliance with the IRS wash sale rule in options. |
| Use Different Strike Prices/Dates | Change the strike price or select an expiration date outside the 30-day window. | Reduces risk of transactions being classified as identical. |
| Trade Similar but Not Identical | Switch to ETFs, mutual funds, or options on different but related securities. | Maintains exposure while avoiding wash sale issues. |
Wait 30 Days Before Re-entering a Similar Position
The easiest and most reliable way to avoid a wash sale is to simply wait. If you sell an option (or any security) at a loss, make sure not to repurchase the same or substantially identical option within 30 days. The IRS rules are strict about this time frame, so patience is your best ally.
Use Different Strike Prices or Expiration Dates
Making small adjustments to strike prices or expiration dates is another way to work around the rule. For instance:
- Switch to an option with a different strike price, you can check out our options screener to do so.
- Choose an expiration date outside the 30-day window from your original trade.
However, be cautious—if the adjustments are minor, the IRS might still classify the new option as “substantially identical.”
Trade Similar but Not Identical Securities
Instead of repurchasing the same option, look for alternatives that can maintain your investment exposure without violating the rule:
- Consider ETFs related to the same industry or sector. These offer broad exposure and are unlikely to be deemed substantially identical to individual stocks or options.
- For stock options, switch to contracts on another stock within the same sector. For example, instead of rebuying a losing option on Company A, trade an option on Company B with similar industry ties.
This approach keeps you active in the market without risking a wash-sale violation.
Other than this, there’s a couple more of things you should do to avoid the wash sale rule in options:
- Track trades carefully: Always know what you’re repurchasing to steer clear of the wash-sale window.
- Document changes: Keeping detailed records of your trades and reasoning helps explain your strategy during a potential IRS audit.
Avoiding the wash sale rule in options can get tricky. Consulting a tax advisor is highly recommended to tackle specific scenarios and ensure you’re fully compliant. With these tactics, you can minimize tax surprises and stay on the right side of IRS regulations.
What Happens if You Trigger the Wash Sale Rule in Options?
You know what a wash sale is and what you should do to avoid it, but what happens if you accidentally trigger one? Unfortunately, the tax consequences and IRS compliance risks can be significant.
Tax Consequences of the Wash Sale Rule in Options
If the wash sale rule in options is violated, here’s what happens:
- Disallowed Losses: You won’t be able to use the loss from the sale to offset other gains or reduce taxable income for the year.
- Cost Basis Adjustment: The disallowed loss is added to the cost basis of your new purchase. While this increases your position’s value for tax purposes, it doesn’t help in the short term.
- Holding Period Carryover: The holding period from the original investment is carried over. This could potentially help you qualify for long-term capital gains rates later.
While there are some potential benefits, such as a higher cost basis reducing taxable gains in the future, the immediate inability to claim a loss can affect your short-term tax strategy.
IRS Compliance Risks
- Risk of Scrutiny: If you frequently violate the wash sale rule in options, it could attract closer IRS attention or even an audit.
- Record-Keeping is Crucial: Carefully track your trades and understand their tax implications. The lack of clear IRS guidance on what counts as “substantially identical” only adds to the complexity.
Proceed with Caution when Dealing with the Wash Sale Rule in Options
To avoid these complications with the wash sale rule in options, always consult a tax professional. They can help you interpret the rules, ensure compliance, and find strategies tailored to your trading approach. Remember, this is not a tax advisory article, so professional guidance is your safest route.
