This year is coming down to the wire, and that means it’s time to start thinking about exchange traded funds (ETFs) and taxes. A primary concern is offsetting capital gains, which you can easily do with ETFs.
Tax savvy investors can get the help they need with ETFs to maintain better returns and offset capital gains taxes. One popular strategy is tax-loss harvesting: you sell a current ETF and purchase a similar one with exposure to the same asset class, taking a loss on the original ETF for tax purposes. [Tax Strategies You Can Use With ETFs.]
Jonathon Burton for The Wall Street Journal says that you have to be careful, though, if you’re tempted to sell an ETF and then buy it again immediately. The IRS’s “wash sale rule” discourages that move, though. You have to wait 31 days to make such a repurchase; otherwise, you won’t be allowed to use the loss to offset gains at tax time. [The Looming Tax Hit Telecom ETFs Face.]
The smartest move is to buy something similar to what you just sold, and ETFs are a natural choice. This can help offset any capital gains taxes. Narrowly-focused sector ETFs, for instance, can serve as a proxy for individual stock holdings. In addition, selling one of these proxy ETFs after holding it only a short time doesn’t trigger any penalty fees.
If you attempt to replace a mutual fund that tracks an index with an ETF based on the same index, you’re likely to run dead into the wash-sale rule. The same applies if you try switching out two competing ETFs tracking the same index. In both cases, the securities are just too similar. Consult your accountant for guidance on doing this to ensure that you’re staying within the guidelines. [Not All ETFs Are Taxed the Same.]
Tisha Guerrero contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.