Wash Sale Rule and Covered Calls: What Every Options Seller Needs to Know

The Short Answer: Yes, Covered Calls Can Trigger a Wash Sale

The wash sale rule can apply to covered calls, and if it does, the IRS will disallow your capital loss deduction. Specifically, selling a deep in-the-money covered call on shares you just sold at a loss — or buying back shares while an in-the-money call is still open — can reset the 30-day wash sale clock. This catches a lot of retail traders off guard at tax time.

The wash sale rule, codified under IRS Section 1091, blocks you from claiming a loss on a stock if you buy a "substantially identical" security within 30 days before or after the sale. The rule was designed to stop investors from selling a loser just to book a tax deduction and then immediately jumping back in. Options on the same stock can count as substantially identical under certain conditions, which is where covered-call sellers run into trouble.

How the Wash Sale Rule Works (The 61-Day Window)

The wash sale window is 61 days total: 30 days before the loss sale, the day of the sale itself, and 30 days after. If you acquire a substantially identical position at any point in that window, your loss is disallowed. The disallowed amount is not gone forever — it gets added to the cost basis of the replacement shares — but it does defer the deduction, which can hurt your current-year tax bill.

For plain stock investors, this rule is straightforward. For covered-call sellers, it gets complicated because an option contract on a stock can be treated as substantially identical to the stock itself, depending on how deep in the money it is. The IRS has not published a bright-line rule on exactly when an option becomes substantially identical, but the agency's guidance and FINRA's investor education materials both confirm that deep in-the-money options carry the highest risk of triggering the rule.

The Specific Scenario That Gets Covered-Call Sellers in Trouble

Here is the situation that creates real problems. Suppose you own 100 shares of AAPL and the stock has dropped. You sell the shares at a loss to harvest the tax deduction. But you still want exposure to AAPL, so you immediately sell a deep in-the-money covered call — say, a $170 strike call when AAPL is trading at $195 — on shares you just repurchased or plan to repurchase.

Because that $170 strike call is so deep in the money, it behaves almost exactly like owning the stock. Its delta is close to 1.0. The IRS can view that option position as substantially identical to the stock you just sold. If the IRS makes that determination, your loss on the original sale is disallowed.

The same problem runs in reverse. Say you sold AAPL shares at a loss on November 1. Then on November 15 — still inside the 30-day window — you sell a deep in-the-money covered call on a new lot of AAPL shares. That call could be enough to trigger the wash sale rule on your November 1 loss.

Out-of-the-money or at-the-money covered calls are generally considered lower risk for wash sale purposes because they do not closely replicate the economics of owning the stock. A covered call with a delta of 0.20 or 0.30 is not substantially identical to the stock. But the further in the money you go, the more the option mirrors the stock, and the more likely the IRS is to treat it as a replacement position.

Worked Example: MSFT Loss Harvest Gone Wrong

Let's walk through a concrete example using Microsoft (MSFT).

Scenario setup: - You bought 100 shares of MSFT at $420 in January. - By October, MSFT has fallen to $370. You decide to harvest the $5,000 loss ($50 per share × 100 shares). - You sell all 100 shares on October 10 for $370, locking in a $5,000 capital loss. - On October 18 — eight days later, still inside the 30-day window — you buy back 100 shares of MSFT at $368 because you want to stay long. - To generate income on your new position, you immediately sell one MSFT covered call with a $340 strike (deep in the money, roughly $28 ITM) expiring in 45 days. You collect $3,200 in premium.

The problem: That $340 strike call has a delta near 0.85. It behaves almost like owning the stock outright. The IRS can treat it as a substantially identical position to the MSFT shares you sold on October 10. Result: your $5,000 loss is disallowed. It gets added to the cost basis of your new MSFT shares, deferring the deduction until you eventually sell those shares — potentially in a different tax year.

What you should have done instead: If you wanted to sell a covered call on your new MSFT shares during the 30-day window, use an at-the-money or out-of-the-money strike. A $380 or $390 strike call on a $368 stock has a delta around 0.40–0.50 and does not closely replicate the economics of the stock. That call is far less likely to be treated as substantially identical. Better yet, wait until the 31st day after your loss sale before selling any covered call on the replacement shares, eliminating the risk entirely.

Risks You Need to Understand Before You Trade

The wash sale risk is real and the IRS does audit it. Here are the key dangers to keep front of mind.

Risk 1 — Automatic reinvestment in IRAs and taxable accounts. If you sell a stock at a loss in a taxable account and your IRA or Roth IRA buys the same stock within the 30-day window, the wash sale rule applies and the loss is permanently disallowed — not just deferred. The IRS confirmed this treatment in Publication 550. You cannot recover that loss by adjusting cost basis in a retirement account.

Risk 2 — Your broker may not catch it. Brokers are required to report wash sales on Form 1099-B for identical securities in the same account. But cross-account wash sales (taxable account to IRA, or spouse's account) are your responsibility to track, not your broker's. FINRA has flagged this as a common investor mistake.

Risk 3 — The IRS has not defined "substantially identical" for options with a precise formula. That ambiguity cuts against you. If you are audited, the IRS has discretion to make the call. Deep in-the-money options are the highest-risk zone.

Risk 4 — Assignment can create unexpected wash sales. If your covered call gets assigned and you are forced to sell shares at a loss, the 30-day clock starts on that assignment date. Any covered call you sell on replacement shares during the next 30 days could disallow that loss.

Risk 5 — Canadian investors face a parallel rule. The Canada Revenue Agency (CRA) has its own superficial loss rule under the Income Tax Act, which operates similarly to the IRS wash sale rule. Canadian investors selling covered calls on TSX-listed stocks should review CRA guidance on superficial losses before harvesting losses.

Practical Rules to Keep Your Loss Deductions Clean

Follow these guidelines and you will dramatically reduce your wash sale exposure as a covered-call seller.

1. Wait 31 days. After selling shares at a loss, wait the full 31 days before buying back the same stock and selling any covered call on it. This is the cleanest solution.

2. If you must re-enter within 30 days, use out-of-the-money strikes. A covered call with a strike 5–10% above the current stock price has a delta well below 0.50 and is unlikely to be treated as substantially identical. The Options Industry Council (OIC) notes that the economic equivalence test is the key factor in determining whether an option triggers wash sale treatment.

3. Consider a different but similar stock. Instead of buying back AAPL after a loss sale, you could buy a similar large-cap tech stock for 31 days. This keeps your market exposure without triggering the wash sale rule. Note that the two stocks must not be substantially identical — a different company's stock generally qualifies.

4. Track all accounts. Use a spreadsheet or tax software to monitor wash sale exposure across your taxable accounts, IRAs, and your spouse's accounts. Do not rely solely on your broker's 1099-B.

5. Talk to a tax professional before year-end. The wash sale rule interacts with your overall tax picture in ways that depend on your income, other gains and losses, and account types. A CPA or tax advisor who understands options can help you sequence trades to maximize deductions legally.

The bottom line: covered calls are a powerful income tool, but they require tax awareness. Selling the wrong strike at the wrong time can erase a deduction you were counting on.

Does selling a covered call trigger the wash sale rule?

Selling a covered call can trigger the wash sale rule if the call is deep in the money and you recently sold the underlying shares at a loss. The IRS looks at whether the option is substantially identical to the stock, and deep in-the-money calls with deltas near 1.0 are the highest risk. Out-of-the-money covered calls are generally not considered substantially identical to the stock.

What happens to my disallowed loss under the wash sale rule?

A disallowed wash sale loss is not gone permanently — it gets added to the cost basis of the replacement shares you purchased. This means you will eventually recover the deduction when you sell those replacement shares, but the deduction is deferred, potentially into a future tax year. The IRS explains this cost basis adjustment in Publication 550.

Can a covered call in my IRA trigger a wash sale on my taxable account?

Yes. If you sell stock at a loss in a taxable account and then buy the same stock — or sell a substantially identical option — inside an IRA or Roth IRA within the 30-day window, the wash sale rule applies. Worse, when the wash sale involves a retirement account, the disallowed loss is permanently lost, not just deferred, because you cannot adjust cost basis in an IRA.

How deep in the money does a covered call have to be to trigger a wash sale?

The IRS has not published a specific delta or moneyness threshold, which is what makes this rule tricky. The general principle is that the more an option's price moves in lockstep with the stock — meaning a high delta, typically above 0.80 — the more likely it is to be treated as substantially identical. Most tax professionals recommend staying at or out of the money during any wash sale window to be safe.

Does the wash sale rule apply to covered calls in Canada?

Canada has a parallel rule called the superficial loss rule, administered by the Canada Revenue Agency (CRA) under the Income Tax Act. It operates on a similar 30-day window and can apply when you sell a security at a loss and reacquire an identical or affiliated property within that period. Canadian investors selling covered calls on stocks they have recently sold at a loss should review CRA guidance on superficial losses before executing those trades.

If my covered call gets assigned and I sell shares at a loss, does the wash sale clock start over?

Yes. When your covered call is assigned and shares are sold at a loss, the wash sale clock starts on the assignment date, not on the date you originally sold the call. If you buy back the same shares or sell a new deep in-the-money covered call on replacement shares within 30 days of that assignment, your loss from the assignment could be disallowed.