wash sale on ETFs question

S

stockmarketbeginner

Hello,

There are three S&P 500 etfs (maybe more):

IVV
VOO
SPY.


Suppose you wanted to go in and out of the S&P 500, but don't want to hit the wash sale rules. If you had IVV, VOO, and SPY, could you buy and sell these.

So suppose the S&P 500 drops 3%. So you sell the IVV for a loss, then immediately buy the VOO. Normally, this would be a "wash sale". But these are two different products sold by two different companies. So they are technically different products, even though they have the same stocks underpinning them.

I'm not trying to dodge the government. I'm not even sure when this would be a good strategy. I'm just wondering what the rules would be.
 
"Substantially similar" instrument is the test there. You might find a few outlier accountants who say this isn't a wash sale, but it pretty clearly is.
stockmarketbeginner said:
Suppose you wanted to go in and out of the S&P 500, but don't want to hit the wash sale rules.
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Also, this right here is exactly what wash sales are designed to prohibit. You want the same exposure, you don't want to pay the tax...wash sale.
 
beerntrading said:
"Substantially similar" instrument is the test there.
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You're wrong - the test for wash sales is "substantially identical", a much stricter standard.

https://www.sec.gov/answers/wash.htm

If you look at examples given in various IRS rulings or guidance, their interpretations are also quite narrow. Examples given include

1. convertible securities and their common stock when they have voting rights, are freely convertible, and are trading at their conversion ratio
2. Stock for stock mergers where all material requirements for closing have been met but pending the final reorganization actually happening

Here is some good discussion on substantially identical fixed income securities. The review of historical rulings may give you some idea for what has been found to be a sufficient difference vs not.

http://g2ft.com/papers/G2FTAdvancedTopicsinWashSales_SubstantiallyIdenticalBonds.pdf

Regarding ETFs or OEFs, there has been no guidance issued. Conservative online authors will often advise not doing these types of loss harvesting swaps, but that's mostly because they'd rather not be wrong and hurt their reputation later than you save money. As a non-exhaustive list of what may vary between ETFs by different issuers tracking the same index, you should consider:

1. Expense ratio
2. Actual holdings and index tracking technique (sampling, full replication, futures vs stocks, etc)
3. Voting rights for the fund manager / advisor
4. Securities lending practices

A while back some mutual funds lost significant amounts of their NAV due to a securities lending blowup (taking Lehman debt for collateral I think), so this is not an insignificant difference at least sometimes. SPY can't due to their entity structure as a unit trust, while others typical do lend out shares.

Just becuase two stocks have a high correlation doesn't mean they represent claims on the same assets, and here you own two different pooled vehicles with different voting rights and different asset pools with different proprietary asset management strategies. Yes, the outcomes may be very similar most of the time, but to say you can't argue they aren't identical in good faith is overstating the case for the IRS in my opinion.
 
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For the life of me, I've never been able to understand the "financial value" to the Wash Sale Rules.

Sure, it keeps traders from generating an "artificial tax loss"... for THIS YEAR.... but by allowing the loss to be added to the cost basis of his next purchase, he's gets to "recover the loss tax- free"... same as if he'd held the stock for the recovery. Net financial result.... Nada!

I see the Wash Sale as stupid, unnecessary busy-work.. messy to account for... maybe even costly if one has to pay the tax preparer to do the accounting. I'm all in favor or scrapping the Wash Sale as it is presently implemented.

If someone has an example of how the tax man benefits (besides perhaps the part about shifting tax... and/or costs/benefits... from one year to another), I'd like to hear it.
 
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MoreLeverage said:
You're wrong - the test for wash sales is "substantially identical", a much stricter standard.

https://www.sec.gov/answers/wash.htm

If you look at examples given in various IRS rulings or guidance, their interpretations are also quite narrow. Examples given include

1. convertible securities and their common stock when they have voting rights, are freely convertible, and are trading at their conversion ratio
2. Stock for stock mergers where all material requirements for closing have been met but pending the final reorganization actually happening

Here is some good discussion on substantially identical fixed income securities. The review of historical rulings may give you some idea for what has been found to be a sufficient difference vs not.

http://g2ft.com/papers/G2FTAdvancedTopicsinWashSales_SubstantiallyIdenticalBonds.pdf

Regarding ETFs or OEFs, there has been no guidance issued. Conservative online authors will often advise not doing these types of loss harvesting swaps, but that's mostly because they'd rather not be wrong and hurt their reputation later than you save money. As a non-exhaustive list of what may vary between ETFs by different issuers tracking the same index, you should consider:

1. Expense ratio
2. Actual holdings and index tracking technique (sampling, full replication, futures vs stocks, etc)
3. Voting rights for the fund manager / advisor
4. Securities lending practices

A while back some mutual funds lost significant amounts of their NAV due to a securities lending blowup (taking Lehman debt for collateral I think), so this is not an insignificant difference at least sometimes. SPY can't due to their entity structure as a unit trust, while others typical do lend out shares.

Just becuase two stocks have a high correlation doesn't mean they represent claims on the same assets, and here you own two different pooled vehicles with different voting rights and different asset pools with different proprietary asset management strategies. Yes, the outcomes may be very similar most of the time, but to say you can't argue they aren't identical in good faith is overstating the case for the IRS in my opinion.
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Oops, my bad. You're right, "Substantially identical". The guidance is (deliberately) vague though. Though I disagree that they aren't substantially identical for tax purposes on two counts.

First, to expand on the above, the ETF is not the holding itself, but each constituent part is. And each one aspires to the same model, the market cap weighted SPX. If we disagree here let's just agree to; the next step on that one is philosophical and probably involves a discussion of platonic "forms".

Secondly, and I think this is among the best wash sale tests, is your intent in the purchase / sale. What's the answer to the question, why VOO instead of SPY? If the answer involves arbitrage, you might have a case (and also, almost certainly, different tax treatment). But having a compelling answer to that question when you're being audited would seem like a baseline necessity. If everyone digs in their heels, you'll be at the mercy of a jury that most likely takes the prosecutor at his word for the interpretation of that law...it under threat of that while you weigh your tax savings vs the penalty.

And finally, on conservative tax advisors who would rather not be wrong than save you money...you're absolutely right. And their decision is a risk / reward calculation is like any other and should inform you're decision.

Scataphagos said:
For the life of me, I've never been able to understand the "financial value" to the Wash Sale Rules.

Sure, it keeps traders from generating an "artificial tax loss"... for THIS YEAR.... but by allowing the loss to be added to the cost basis of his next purchase, he's gets to "recover the loss tax- free"... same as if he'd held the stock for the recovery. Net financial result.... Nada!

I see the Wash Sale as stupid, unnecessary busy-work.. messy to account for... maybe even costly if one has to pay the tax preparer to do the accounting. I'm all in favor or scrapping the Wash Sale as it is presently implemented.

If someone has an example of how the tax man benefits (besides perhaps the part about shifting tax... and/or costs/benefits... from one year to another), I'd like to hear it.
More...
Well "time value" of money. Ostensibly.

Though I have absolutely no doubt whatsoever this was a deliberate lobby effort by unscrupulous prosecutors / law enforcement to write vaguery into law that they can exploit to gain (even more!!!) leverage over you in pretrial negotiations. And drives at the crux of my firm belief that plea bargains are unconstitutional because they give so much leverage to prosecutors (and the absolute farce when you're paraded in front off a judge to say you made this decision to plead guilty freely and without coercion).


So moral of the story, if you saved $100 in taxes, the audit is as much a waste of the auditor's time as yours and call it a wash sale or not. If you saved $1 million in taxes, you'll be paying more than your fair share in taxes either by your conservative interpretation of "wash sale" or under the thumb of a prosecutor who cares more about winning than justice.
 
beerntrading said:
So moral of the story, if you saved $100 in taxes, the audit is as much a waste of the auditor's time as yours and call it a wash sale or not. If you saved $1 million in taxes, you'll be paying more than your fair share in taxes either by your conservative interpretation of "wash sale" or under the thumb of a prosecutor who cares more about winning than justice.
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Even with your premise... the Wash Sale doesn't "save you taxes"... it costs you taxes this year by disallowing the deduction for the loss. Then next year, saves you the amount in taxes it cost you last year by adding last year's disallowed loss to the cost basis of your regained position in this year.

"Time value of money"? Seems pretty thin, but that could be it. By disallowing the loss this year, tax payer pays more. Though he would be able to recover the loss tax free next year and pay less tax in the following year thanks to the tax-free recovery of his cost basis... well, that's an issue for another time. ??

Considering how easy it is to avoid the Wash Sale, seems not worth the bother.
 
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Scataphagos said:
Even with premise... the Wash Sale doesn't "save you taxes"... it costs you taxes this year by disallowing the deduction for the loss. Then next year, saves you the amount in taxes it cost you last year.
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Again, time value of money, ostensibly.

In aggregate, that argument is true and the government would have cash flow issues. And in reality, without this law people would exploit the tax treatment of capital gains. The problem is the tax treatment of capital gains necessitating such a clumsy "fix".

But I very honestly believe that "fix" has less to do with fixing than some attorney knowing he could sell that Congress with the time value argument without Congress realizing the golden goose (of power, not money) they just handed to prosecutors...or realizing and don't care.
 
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