Tax Loss Harvesting Question

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Bracket
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Tax Loss Harvesting Question

Post by Bracket »

What is the most commonly used method to avoid wash sales when holding the same investment in both taxable and tax deferred accounts?

For example, I have vanguard small cap value (VSIAX/VISVX) in both taxable and my Roth IRA. I have all my taxable funds set to NOT reinvest dividends and capital gains, and my IRA funds set TO reinvest them. So if I were to harvest a loss in VSIAX by selling in taxable, I guess the simplest answer is to check when the dividends are coming to avoid selling within 60 days of when the dividends in the IRA are about to be distributed and reinvested, and thereby cause a wash sale.

I'm wondering if anyone instead opts to turn off automatic reinvestment inside their IRA or 401k (can you even do that inside a 401k? Never tried.) and if so where do they then direct that money to go?

Thanks
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powermega
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Re: Tax Loss Harvesting Question

Post by powermega »

Your settings for dividends/distributions is what I would use too. Getting the distributions in cash, along with new money deposits, can help you keep your allocations balanced without having to sell the gainers (triggering taxes).

I think you raise an interesting point when you have investment allocations that span taxable and tax-deferred/non-taxable (TD/TF) accounts. In your case, you could realize the loss in the taxable account, and purchase the same amount in your TD/TF account. As a balance, you could swap the proceeds from the realized loss into a different fund in your taxable account, and reduce the holdings in that fund in your TD/TF account. After 31 days, you could reverse all this to get back to where you started. This way, the overall portfolio allocation between all accounts does not change at all, but you can realize the loss. For example:

1. Sell small cap fund in taxable account for $10k, realizing a loss. Buy $10k worth of the same fund in your TD/TF accounts.
2. Use $10k proceeds from sale to buy a large cap fund (or any fund other than the one you sold in step 1) in your taxable account. Sell $10k worth of the same fund in your TD/TF account.
3. After 31 days, unwind positions from steps 1 and 2, and get back to original allocation between all accounts.

I never really thought about that until you alluded to it in this thread. I like this better than trying to find an "equivalent" fund to swap into for 31 days.
Even a stopped clock is right twice a day.
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House Blend
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Re: Tax Loss Harvesting Question

Post by House Blend »

powermega wrote: I think you raise an interesting point when you have investment allocations that span taxable and tax-deferred/non-taxable (TD/TF) accounts. In your case, you could realize the loss in the taxable account, and purchase the same amount in your TD/TF account. As a balance, you could swap the proceeds from the realized loss into a different fund in your taxable account, and reduce the holdings in that fund in your TD/TF account. After 31 days, you could reverse all this to get back to where you started. This way, the overall portfolio allocation between all accounts does not change at all, but you can realize the loss.
No. If the TD/TF account is an IRA, the IRS has made it clear that this (a) counts as a wash sale, and (b) the replacement shares that you buy in the IRA cannot acquire the part of the loss that was washed. In other words, you have permanently decreased the cost basis of your taxable holdings with no compensating ability to deduct the loss from your taxable income. So this actually costs you money, whereas a wash sale in which all the activity takes place in taxable is simply a matter of deferring losses until replacement shares are sold.
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powermega
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Re: Tax Loss Harvesting Question

Post by powermega »

House Blend wrote:
powermega wrote: I think you raise an interesting point when you have investment allocations that span taxable and tax-deferred/non-taxable (TD/TF) accounts. In your case, you could realize the loss in the taxable account, and purchase the same amount in your TD/TF account. As a balance, you could swap the proceeds from the realized loss into a different fund in your taxable account, and reduce the holdings in that fund in your TD/TF account. After 31 days, you could reverse all this to get back to where you started. This way, the overall portfolio allocation between all accounts does not change at all, but you can realize the loss.
No. If the TD/TF account is an IRA, the IRS has made it clear that this (a) counts as a wash sale, and (b) the replacement shares that you buy in the IRA cannot acquire the part of the loss that was washed. In other words, you have permanently decreased the cost basis of your taxable holdings with no compensating ability to deduct the loss from your taxable income. So this actually costs you money, whereas a wash sale in which all the activity takes place in taxable is simply a matter of deferring losses until replacement shares are sold.
I did not realize the IRS would count this as a wash. I guess it's back to using a temporary "swap fund" that doesn't violate the wash rules.
Even a stopped clock is right twice a day.
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House Blend
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Re: Tax Loss Harvesting Question

Post by House Blend »

Bracket wrote:What is the most commonly used method to avoid wash sales when holding the same investment in both taxable and tax deferred accounts?

For example, I have vanguard small cap value (VSIAX/VISVX) in both taxable and my Roth IRA. I have all my taxable funds set to NOT reinvest dividends and capital gains, and my IRA funds set TO reinvest them. So if I were to harvest a loss in VSIAX by selling in taxable, I guess the simplest answer is to check when the dividends are coming to avoid selling within 60 days of when the dividends in the IRA are about to be distributed and reinvested, and thereby cause a wash sale.

I'm wondering if anyone instead opts to turn off automatic reinvestment inside their IRA or 401k (can you even do that inside a 401k? Never tried.) and if so where do they then direct that money to go?
My preferred method for avoiding these wash sales is to use different funds.

The IRS has not clarified whether buying replacement shares in a 401K counts as a wash, but given that it does count in an IRA, my working hypothesis is that it counts in a 401K too. Other people on this forum have taken other views.

And in my employer's plan, there are no configuration options for distributions. All funds have all distributions reinvested whether you like it or not. Maybe your 401K is different.

If you have Fund X in an IRA and taxable, I would recommend turning off dividend and cap gain reinvestment in the IRA. Instead, direct all distributions to some other fund in the IRA. (Yes, this means having at least two different funds in the IRA.)

In the case of a fund like VG Small Value, which only has annual distributions, you could simply avoid TLH during that one 61 day window in Q4. (But beware it can sometimes have tiny unscheduled make-up distributions in March. Perhaps those are tiny enough not to care about.)

For a fund with quarterly distributions it's a bigger PITA. The only other wash-avoiding options are to limit your TLH activity to the four unaffected months of the year, or (if the distribution is coming after the sale), transfer out of the fund in the IRA before the distribution takes place.
bobbun
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Re: Tax Loss Harvesting Question

Post by bobbun »

Bracket wrote:What is the most commonly used method to avoid wash sales when holding the same investment in both taxable and tax deferred accounts?
I think the most common method is "Don't do that."

If I were doing what you're describing and holding some of the same funds, I would probably direct investment income in the IRA into my bond fund, and the bond fund I held in taxable would be a tax-exempt fund. This would eliminate the problem of accidental wash sales due to income reinvestment, and should be reasonable most of the time. It's probably not so reasonable for avoiding problems with other types of frequent investments, however, as there's some risk of deviating significantly from your defined asset allocation.
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Bracket
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Re: Tax Loss Harvesting Question

Post by Bracket »

Good discussion, I appreciate all the replies.

Just to clarify, my assumption was that buying the same or similar fund in ANY account, be it taxable, IRA, or 401k, would cause a wash sale. I was unaware that there was controversy regarding whether or not this applied to 401k's. Personally I would probably not test this, but I do not hold any identical funds in my taxable and 401k anyway.


It sounds like the simplest solution would be to "not do that" as Bobbun says, however when I used to not have a taxable account I filled my Roth with REITs, EM, and small cap value, so that's how I got where I am. I have no bonds at all in my Roth, otherwise I would have liked the idea of redirecting all my dividends into bonds.

However, Houseblend and Bobbun have given me an idea: why not redirect all my IRA dividends into REITs? Due to the $5500 limit on IRA contributions, I am chronically underweight in REITS (vs what my IPS says I should have) and this might help with that. In addition, I do not and will never have REITs in taxable, and will therefore never try to tax loss harvest my REITs, so if I put all my dividends there I will never have to worry about triggering an inadvertent wash sale. I would have to just make sure my REIT allocation didn't explode to more than my IPS called for, but I don't see this ever happening given that my IRA is a relatively small part of my portfolio and limited to $5500 per year. I never thought of doing this before but it seems like a very good solution.
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ogd
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Re: Tax Loss Harvesting Question

Post by ogd »

Bracket: given the IRS's stance on IRAs I am fairly confident that it applies to 401k's, and like others have said I wouldn't want to test it.

This is a reason not to reinvest dividends in tax-advantaged accounts, at least for the funds you have in common with taxable. Or, to not have funds in common (dividend reinvestment is the only option in some 401k's) and pick slightly different ones.

Your plan to accumulate REITs with dividends is okay, but since sales in tax-advantaged accounts have no impact, you could also rebalance to your IPS right now without waiting for dividends. Then on an ongoing basis, accumulate the dividends in a single fund that you allocate at infrequent intervals, one that you don't use elsewhere (or Prime Money Market). You don't sound like the type to forget about dividend money for the years it would take for the delay to have a significant impact.
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Peter Foley
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Re: Tax Loss Harvesting Question

Post by Peter Foley »

By far the simplest solution is to hold similar but not identical funds in taxable and retirement accounts. For example, hold the extended market fund (small and mid cap) in taxable and the small cap fund in your 401k.

I hold total stock market in taxable and would have no qualms about selling some for a loss in taxable and buying the S&P index fund in my retirement account. The two track closely enough that I would not be concerned.
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Re: Tax Loss Harvesting Question

Post by placeholder »

ogd wrote:Bracket: given the IRS's stance on IRAs I am fairly confident that it applies to 401k's
I'm not sure why since they could have just as well said so in the publications but didn't.
Topic Author
Bracket
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Re: Tax Loss Harvesting Question

Post by Bracket »

placeholder wrote:
ogd wrote:Bracket: given the IRS's stance on IRAs I am fairly confident that it applies to 401k's
I'm not sure why since they could have just as well said so in the publications but didn't.
This raises another question I had not considered: what about 529 plans? Can activity in there trigger a wash sale? I hold Vanguard index funds in my 529, like total int'l stock index, so if I tried to harvest a loss in my regular taxable account in this fund while my 529 is automatically reinvesting in it, what happens?

My 529 (VA) is very opaque--I own "units" in a "portfolio" that invests in the index fund, as opposed to shares in the fund itself. I think. And unlike my 401k, which will show me actual "dividends" that get reinvested on a specific date, I see no such thing on any 529 statement. Instead I see a beginning value for the month and an end of month value, and if I recall correctly the number of units doesn't ever change unless I actually invest new money.

So while I am sure reinvestment of dividends must be going on behind the scenes in the 529 (and is somehow "converted"' into an increase in share value) , I would also guess that maybe since my statement shows no actual "buying" of the fund this would actually NOT trigger a wash sale? Maybe?
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ogd
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Re: Tax Loss Harvesting Question

Post by ogd »

Bracket: see http://www.bogleheads.org/wiki/Collecti ... ent_Trusts . This structure does indeed prevent the dividend reinvestment problem by avoiding explicit purchases, much like a fund's internal trading does not create wash sales with the underlying stocks.

If this wasn't the case, I'd be wary of wash sales triggered by purchases in the 529, like a 401k and an IRA. The IRS has a habit of leaving things unclear, then clarifying retroactively for who knows what reason, and 529/401k seems like a no brainer given the clarifications about IRA.
Last edited by ogd on Thu Jun 05, 2014 11:59 am, edited 1 time in total.
sscritic
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Re: Tax Loss Harvesting Question

Post by sscritic »

I like to look at the law. Reading helps in this regard. You can read an IRS publication, the Code of Federal Regulations, or the United States Code (I find these better than most of the things I find on the internet).

When you read, you need to know the meanings of words. Two words you should know are buy and acquire. These are not the same words. For example, if your mother gives you $10,000 worth of I bonds in May and you buy $10,000 worth of I bonds in June, are you breaking a federal regulation? You acquired $20k of bonds but only bought $10k. Does the $10k limit apply to your acquisition or to your purchase?

The IRS makes a similar distinction when it comes to the wash sale rule.

A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale you:

1. Buy substantially identical stock or securities,
2. Acquire substantially identical stock or securities (under certain conditions that I have removed)
3. (Also removed)
4. (And yet again)


Now I admit this answers none of your questions, as substantially identical is not defined here. However, you may want to think about whether there are occasions when you acquire shares in your 401(k) even if you don't buy them and whether 2 applies if you do decide you acquired shares.
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Bracket
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Re: Tax Loss Harvesting Question

Post by Bracket »

Thanks for the reference OGD. I double checked my 529 statements and there are indeed no dividends, the NAV just goes up while the number of shares stays the same.

And this statement from your reference I think makes it clear that with this structure inadvertent wash sales should be a non-issue.

" A CIT does not make dividend distributions. Dividends are added and accumulate in the net asset value of a CIT share."
sscritic
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Re: Tax Loss Harvesting Question

Post by sscritic »

The fact that the CIT doesn't make distributions is not really the question in my mind. The real issue is who you is.

You have an IRA. The I is IRA is individual, meaning you.
You have a living trust. The living trust is not you (which is why your trust can buy $10k of iBonds and you can buy $10k of iBonds in the same year).

Your living trust sells shares of fund A; your IRA buys shares of fund A. Is this a wash sale? Of course. The fact that you and your trust are not the same person doesn't matter. The trust is a pass-through and is acting on your behalf.

In this case, the CIT collects dividends from the funds; the CIT then buys more shares of the fund. While the CIT does not give you more shares of your CIT, each share that you own of the CIT now represents more shares of the fund. If the CIT is acting as your agent in the same way that your trust acts as your agent, then "you" have purchased more shares of the fund (but not of the CIT). Part of me thinks a CIT and a trust are not the same in the sense of being your agents, but then again part of me thinks they are. I would avoid the issue.
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Bracket
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Re: Tax Loss Harvesting Question

Post by Bracket »

sscritic wrote:The fact that the CIT doesn't make distributions is not really the question in my mind. The real issue is who you is.

You have an IRA. The I is IRA is individual, meaning you.
You have a living trust. The living trust is not you (which is why your trust can buy $10k of iBonds and you can buy $10k of iBonds in the same year).

Your living trust sells shares of fund A; your IRA buys shares of fund A. Is this a wash sale? Of course. The fact that you and your trust are not the same person doesn't matter. The trust is a pass-through and is acting on your behalf.

In this case, the CIT collects dividends from the funds; the CIT then buys more shares of the fund. While the CIT does not give you more shares of your CIT, each share that you own of the CIT now represents more shares of the fund. If the CIT is acting as your agent in the same way that your trust acts as your agent, then "you" have purchased more shares of the fund (but not of the CIT). Part of me thinks a CIT and a trust are not the same in the sense of being your agents, but then again part of me thinks they are. I would avoid the issue.
I suppose you could be right, but I would then have no idea when the CIT is reinvesting those dividends, so how could I possibly make sure no purchases were being made within + or - 30 days of me selling the same fund for a loss? And as OGD alluded to, what if I own S&P 500 index and also Apple stock. If I sell apple at a loss while my VFINX is buying it at an unknown date, is that somehow a wash sale too? How would I ever hope to avoid one then?

I suppose I could just check the ex dividend date of the fund and just not sell any around that time. I would also think that a trust created by myself and a CIT managed by the state of VA would be different. I would argue that one is clearly "me," or close enough, but I don't think the other one is. I could of course be wrong though.
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