Substantially Identical Security

The wash sale rule under IRC Section 1091 prohibits investors from claiming a capital loss on a security if they purchase a substantially identical security within 30 days before or 30 days after the sale — a 61-day window centered on the date of the loss sale. The rule exists to prevent investors from creating artificial tax losses by temporarily exiting and re-entering economically equivalent positions without meaningful change in investment exposure.

The IRS has not published a precise, exhaustive definition of substantially identical, which creates both ambiguity and planning opportunities. However, well-established interpretations exist. Identical securities are clearly substantially identical: selling 100 shares of Apple and buying 100 shares of Apple the next day triggers a wash sale. Bonds from the same issuer with different maturities or coupon rates are generally not considered substantially identical. Preferred stock of a company is generally not substantially identical to the common stock of the same company. A contract or option to buy substantially identical stock can itself trigger a wash sale.

For equity mutual funds and ETFs, the substantially identical analysis depends on the specific funds involved. Two S&P 500 index funds from different providers — for example, Vanguard VOO and iShares IVV — are widely considered not substantially identical by tax practitioners, because they are separate legal entities with different managers, different expense ratios, and different specific holdings mixes, even though they track the same index. This interpretation is widely used in tax-loss harvesting strategies: investors sell one S&P 500 ETF at a loss and immediately buy a comparable S&P 500 ETF from a different provider to maintain market exposure while realizing the loss.

Crypto assets (such as Bitcoin) were not subject to the wash sale rule as of the current tax code, because they are treated as property rather than securities — a distinction that may change pending future Congressional action. Individual stocks do not have an obvious substantially identical replacement in the way broad index funds do, making stock-level loss harvesting more challenging without temporarily reducing exposure to the position.

When a wash sale occurs, the disallowed loss is not permanently lost. Instead, it is added to the cost basis of the replacement security, effectively deferring the loss until the replacement position is sold. If the replacement security is held in a different type of account, however — for example, if the loss is realized in a taxable account and replacement shares are purchased inside an IRA — the loss is permanently disallowed, not merely deferred, because the IRA basis adjustment is not economically equivalent to a taxable basis adjustment.