The overall effect that the wash sale rule has on your taxes is that it may prevent you from deducting a loss when you sell a stock. Everyone knows that when the value of your stock goes down, you have lost money. You may not claim that loss on your tax return until you have sold the stock. Conflicts arise as you want to be able to deduct the loss but you may also want to keep the stock because you think it may bounce back.
The wash rule comes in to play when you sell the stock in order to be able to deduct the loss for tax purposes but then buy it back right away. Under the tax law, you are not allowed to deduct the loss on your tax return if you buy replacement stock shortly before or after the sale of the initial stock.
A wash sale occurs when you sell stock at a loss and buy identical securities either 30 days prior or 30 days after the sale of the stock. The wash sale period for any loss consists of 61 calendar days, 30 days prior to the sale, the day of the sale, and the 30 days following the sale. Wash sale rules do not only apply if you acquire stock, they also apply if you enter into a contract or option to acquire stock.
Not only are you not allowed to claim the loss on the sale of your stock if you enter into a wash sale, your loss instead has to be added to the basis of the replacement stock. For example, if you purchased shares of stock at $70, the stock declined to $50 and you sold it then you bought back the shares at $75, the replacement shares now have a cost basis of $95 per share (the $75 paid per replacement share plus the $20 wash sale adjustment.) Basically, what this usually does is give you the same tax benefit at a later time. That is unless you don't sell the replacement stock in the same year and your loss is postponed until a time when the deduction is of far less value or you die before selling the replacement stock.
If a person who is related to you or your IRA purchases replacement stock, your loss may be disallowed under a different rule whereby you may be treated as if you made an indirect sale to a related person. In this case, you could lose the benefit of deduction completely and permanently.