The Wash Sale Rule and day trading (aka: Superficial Loss Rule in Canada)


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Something it appears many day traders are not aware of, or tend to forget about, is the 30 day wash sale rule here in the US. Canada has their own version called the superficial loss rule and it is essentially the same. For us day traders it works like this. Say you purchase a stock at 10:00 for $100 then sell it at some point for a loss... say $80... then buy it back later in the day for $110 and sell it at the close for $150.

Congratulations! You have invoked the 30 day rule. That first $20 loss is disallowed and has to be added to the cost basis of the second purchase. So, in this example, instead of a profit of $40 on that second trade you only had a profit of $20. That's because you have to add that first $20 loss to the cost basis of the second purchase of $110 and that made the purchase $130.

This is a simple example and I have not included the costs for commissions, if you pay them. Can you imagine the accounting mess you'll have if you are in and out of the same stock multiple times per day?

Now, here is where it gets bad. Real bad.

You buy 1000 shares of a stock at $10/share for a total cost basis of $10,000. You see the bottom fall out and sell the whole lot for $7/share or $7,000. You have a loss of $3,000, now. If you do nothing in that stock for 30 days you're safe. Add that loss in to your capital gains at the end of the year.

However, a week later you see this stock is moving. You want to get in on the action so you buy 50 shares this time at $7/share. You have $350 invested. Later that day you sell the lot for $8/share or $400. Great, you made a fast $50!

Actually, you just screwed yourself. Since you bought into this stock in less that the 30 day waiting period that original $3,000 loss is now disallowed by the IRS. You cannot declare it as a loss and it's gone for good.

The way around all this is not to repurchase a stock you just took a loss on for 30 days. This means keeping careful notes on what you buy and when you bought. BTW: You cannot rely on your broker to keep track of this for you. They are not required to do so. That is up to you!

I'm not a tax accountant or a tax lawyer. This information is from what I have gathered reading up on the subject. If I'm wrong on any of it, please correct me. It is a complicated subject, to be sure, but it can bite us in the behind if we get it wrong.
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