Taking Losses for Fun and Profit

Most obviously, you can't violate the "wash sale" guidelines which effectively keep you out of that investment for 61 days (the 30 days before the sale and the 30 days after). If you sell and "immediately rebuy" within those 30 days, the loss cannot be deducted.

In your case (the sell, realize, and rebuy method) you are locked out of repurchasing that investment for 8.5% of a year (the 30 calendar days after the loss sale). That can make a big difference.

Of course, another investment may be purchased in that time. I have heard of people who find two very similar index tracking funds and alternate purchasing the two in this kind of case. Simply sell the one at a loss and immediately purchase the second. Rinse. Repeat. Hopefully, you will never again realize a loss and this will never matter again!

The only gotcha is the 30-day wash rule. If you sell-and-buy to realize the capital loss, you must wait 31 days before re-buying. You do have to miss a month of change in the investment you sold. In fact, the IRS will disallow the loss if you re-invest the money in any substantially equal investment within the 30 days, such as selling Vanguard's S&P fund, and buying SPY... However, you might get away with selling SPY and buying VTI (a wider scoped investment, even though it has similar performance). I will await professionals to chip in... Joe Weinstein

Good point on the substantially equal investment. I was probably vague or misleading in my earlier post. The exact ETFs I was thinking of were SPY and VTI, but they may also be too closely related.

Anyone got any experience with the IRS on this?

It's never been addressed clearly. I've thought about setting up a bunch of wash sales & getting a PLR for the final word on it. Examples - are these "substantially identical"?

S&P 500 index fund from Vanguard S&P 500 index fund from Fidelity S&P 500 index ETF from iShares S&P 500 index futures covering the wash-sale period Russell 1000 index fund (highly correlated to S&P 500) Actively managed fund with large overlap with S&P 500

Similar: Russell 2000 index fund (sold at loss) Buy: Russell 3000 index fund Short: Russell 1000 index fund

Many variations on these.

But for the OP -- yes this is classic "tax management" of a portfolio. You can do it as well with reinvested dividends of those mutual funds, as long as you haven't used "average cost basis" when selling the fund in the past. You use "specific identification" and sell whatever lots result in a loss. It's typical to have at least some loss positions in a broadly diversified portfolio where you're investing cash regularly.

This can also be an argument for using individual stocks instead of mutual funds. If you hold the Dow 30 individually you'll have some big-gain and big-loss positions. If you hold the ETF (ticker DIA) these are internal to the fund so there's less chance for tax-loss harvesting.

A further wrinkle on it is using the big-gain positions for charitable contributions, in effect gifting away your capital gains.

-Tad

A few things to consider:

First, this is not tax advice! Just pointing out verbiage and terms from relevant tax docs.

Your choice of a $3k loss for the example was a good one as that appears to be the deductible limit of capital losses according to

if you don't have othercapital gains that year to offset against. There is also a notion ofcarrying over losses to future years if you really take it in theshorts on a given investment, detailed in the capital loss carryoverworksheet stuff.

But that's immaterial since I think the IRS calls your clever plan a "wash sale" and disallows that deduction if you try to turn it inside of 30 days: Pub 550 Wash Sale

Now the interesting question is "if I wait 31 days to buy it back, is THAT kosher?" Consult your tax advisor. :-)

I haven't, but I recall the wash sale question I answer every year in my tax program. :-)

Best Regards,

-- Todd H.

substantially equal investment within

That's good to know. I was unaware of the wash rule. This seems like a rule with a LOT of gray area. For example, which of the following pairs are substantially equal investments:

S&P 500 index fund from different brokers (e.g. Vanguard vs. Fidelity) S&P 500 index fund vs. SPY? S&P 500 index fund vs. large-cap index fund (e.g. MSCI 750)?

All three of these pairs have very strong correlation. Is there some sort of test for "substantial equality"?

--Bill

I did this during the 2000 - 2002 bull market and managed to get myself in a position where I had paid negative taxes on my investment gains. Of course, the caveats mentioned by kastnna and Joe still apply.

-Will

The flip answer, which is probably the final word unfortunately, is "Yes, an audit."

-- Todd H.

substantially equal investment within

Fairmark discusses this and concludes that the above are substantially identical. see

You could find an index that is a superset of the index you are selling, S&P 1500 to replace the S&P 500, for example. The chance of them diverging enough to cause heartburn over 31 days is minimal, compare ISI (the iShare for S&P 1500) to SPY for 2 years and you'll see about 1% difference over 2 years time.

JOE

This works well. Only warning is that the stock must be a long term cap gain, this trick can't be used to avoid short term gains. Given that long term gains can have a phantom rate over 20% (due to AMT and loss of exemptions), it can make the deduction worth 50%. Ex, Stock basis $2000, present value $10000. In 33% bracket, get back $3300 for the donation. But had you sold the stock at the 20% phantom rate, tax of $1600 would have been due, so the net savings is $4900. Of course you don't give away money just for the refund, but having the IRS act as my partner in philanthropy is better than some alternative ways they can spend my money.

JOE

There's one more benefit that you're overlooking (and I'm having great difficulty writing this so it makes sense because I don't know the terminology.)

When you sell a long-term holding at a loss, you have to balance that loss against your long-term capital gains first, then any excess up to $3000 can written off against *ordinary income* at your marginal tax rate. (then anything left beyond $3000 is carried forward to the next year) By giving all your capital gains to charity, you have no LT gains so the *first* $3000 of losses get written of against ordinary income.

This assumes you were gonna give to charity anyway, and you are just giving appreciated long-term assets instead of cash.

Unfortunately for me, much of my charitable giving goes to my church, and the rest gets spread around to a bunch of charities. I'm currently going to a tiny church that can't really handle gifts of stock because their bank would screw them with high commissions and account management fees (I checked.) :-( This used to work really well when I went to a big church.

Best regards, Bob

Schwab Charitable fund handles this quite well. $10,000 to open the account, if you are fortunate enough to want to donate this much in a given year. Then you tell them where to donate cash, minimum of $250 at a time. For those with variable incomes or the occasional windfall, this can work out well, but as you said, only if you were donating already. The letter with the check indicates the name of your fund "JoeTaxpayer Charity Account" and your actual name, along with whatever note you wish, such as "annual fund" "building fund", etc.

There is talk that they (and Fidelity) have plans to lower the initial transaction to $5000 to gain more accounts. JOE

Where were you investing? In the USA 2000 to 2002 was a significant BEAR market.

The "2000 - 2002" bull market? Where was this? Peru? Vietnam?

Sorry, being a little too optimistic. I meant the bear market of 2000 -

2002. I'm glad I didn't generate big losses in a bull market...

-Will

The market for Pokemon cards, duh. :)

-Will

I agree, but one needs many stocks to assemble a diversified portfolio, and some people may not have the money or the time to buy enough stocks. They can consider replicating the S&P 500 with sector ETFs or the EAFE (a foreign stock index) with country ETFs to get some (but not all) of the benefits of tax-loss harvesting in individual stocks with less hasle.

agree, but one needs many stocks to assemble a diversified portfolio,

Some say yes, some say no. I think Kate Thomas at Fairmark.com makes a good argument why it won't.