IRS Wash Sale Rule: can a single lot be adjusted more than once?

Question

When the only eligible replacement shares for a wash sale basis adjustment have already been adjusted, are they adjusted again? Or is the loss allowed? Example: Suppose this is the entirety of my trading activity. Day 1: buy XYZ $10 -> LOT 1 Day 2: buy XYZ $20 -> LOT 2 Day 3: sell XYZ $10 <- LOT 2 -- $10 disallowed loss increases LOT 1 basis to $20. Day 4: buy XYZ $20 -> LOT 3 Day 5: sell XYZ $10 <- LOT 3 -- ?? is LOT 1 adjusted to $30, or is the loss allowed?? Note that when selling I am electing to use the specific lots: lots 2 and 3. Lot 1 is never sold. On day 6, what is my loss, and what is the cost basis of LOT 1? A straight reading of the rule implies the second loss is disallowed, and the basis of LOT 1 is adjusted twice, and this is what I'm betting happens. However, I've encountered sources that say that an already-adjusted lot is ineligible for adjustment. There is a related question here, but the whole FIFO accounting method doesn't seem relevant here -- I am explicitly keeping track of the individual lots I buy and sell; and in any case I didn't get a clear answer. I'd appreciate it if someone could give a definitive answer here.

D Stanley · Answer

First let's clear up what the "wash sale" rule actually does.  It does not prevent a loss. It defers a loss if the loss would be claimed in one tax year and a subsequent sale happens in another. So if all of these transactions happen in the same tax year, the losses are all just deferred until you close out your entire position in the stock (so long as you don't open it back up for 30 days).
So in your scenario, after the sales of lots 2 and 3, the $10 loss for each sale would be applied to the basis of the first lot, meaning that you have a lot of stock with a cost basis of $30. If you sell that lot within the same tax year, then everything washes and there's no effect of the "wash sales". If you sell in in a subsequent tax year, then the higher cost basis reduces your taxable gain (or increases the loss, whichever is applicable) by the amount of the loss that you would have claimed in the original tax year.
Note that your cost basis would be the same no matter what lot selection you use - if you used FIFO, then you would have sold lot 1 for no gain on day 3, and would have sold lot 2 for a $10 loss on day 5, which would adjust the basis for lot 3 to $30. In the end you still end up with a lot of stock with a $30 cost basis. So choosing different lots would give you the same effect with only one adjustment.
I can't find any "definitive" source that explicitly states whether one lot can be adjusted multiple times, but given the spirit of the rule and the intended effect, I strongly suspect that the end result should be the same in any case - owning a lot of stock with a cost basis of $30.

IRS Wash Sale Rule: can a single lot be adjusted more than once?

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