Hoping for help on first tax loss harvesting scenario

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Topic Author
MilitaryDoc
Posts: 70
Joined: Sun Jan 12, 2014 10:23 am

Hoping for help on first tax loss harvesting scenario

Post by MilitaryDoc » Tue Mar 24, 2020 2:15 pm

Hello all,

I’m looking for some guidance on executing a tax loss harvesting maneuver for the first time. Thus far, I’ve read through some TLH posts, the TLH wiki page, and spoke to a Vanguard rep (who couldn’t answer all my questions unfortunately).

Taxable:
Vanguard Total Stock Market Index (VTSAX)— DOWN ~30k
Vanguard Total International Stock Index (VTIAX)— DOWN ~75K
Vanguard Prime Money Market Fund (VMMXX)

Retirement:
His Roth IRA:
Vanguard Total Stock Market Index (VTSAX)
His Roth/Traditional TSP:
G Fund
C Fund
S Fund
Her Roth IRA:
Vanguard Total Stock Market Index (VTSAX)
Her Roth/Traditional TSP:
F Fund
C Fund

Since we are down 75k with VTIAX (all shares as of yesterday’s COB) and ~30k with VTSAX (only portion of our total shares), we are thinking it would be advantageous to harvest our losses. So far, I have cancelled (diverted) automatic investments and reinvestments of dividends and capital gains (for only taxable holdings). I wasn’t able to turn off reinvestments for the Roth IRA because I would need to add a small amount of funds to another holding like VMMXX to allow for transfer of dividends to that fund. Since the 1st quarter dividends are about to be distributed for VTSAX today or tomorrow, I wouldn’t be able to avoid the reinvestment in the Roth IRAs in time. Unfortunately, we are left with approximately 3.5k of purchases for each VTIAX and VTSAX within the past 31 days (some 1st quarter distributions in both taxable and Roth IRA accounts AND a couple automatic investments in the taxable account).

Questions-
1. We had an automatic investment for both VTSAX and VTIAX on 2/24 we want to avoid counting against our total tax loss harvest amount. I am planning to exchange funds (sell initial funds (most likely all of VTIAX and only VTSAX shares with losses) and buy replacements all in one day) either this Thursday or Friday.
Are both the 31st and 32nd day since the 2/24 purchased shares date acceptable?
Do you think FTSE All-World ex-US Index (VFWAX) and Vanguard Large-Cap Index (VLCAX) are good replacements for VTIAX and VTSAX, respectively?
Is it a good time to TLH given our situation?
Do you have any other recommendations?

2. Since we had approximately 3.5k of purchases for each VTIAX and VTSAX within the past 30 days, will this mean an equal amount of "harvested" losses will simply be disallowed as wash sales?
Will we be left with ~98k in losses for tax benefit to cancel out any 2020 gains plus 3k of ordinary income with the rest counting as carryover losses, which can be used to deduct 3k of income in future years?
Or will all of the realized losses be disallowed since we made purchases within the past 31 days?

3. On the 31st day, I can either keep replacement funds and any remaining initial funds or return to the initial funds. This all depends on how the markets moves. Is this correct?

4. Does the 6-mth rule for tax exempt interest affect this scenario? I couldn’t ascertain the answer to this question by looking at VTIAX’s and VTSAX’s prospectuses.

Thank you!!

rkhusky
Posts: 9512
Joined: Thu Aug 18, 2011 8:09 pm

Re: Hoping for help on first tax loss harvesting scenario

Post by rkhusky » Tue Mar 24, 2020 2:39 pm

You can sell all VTSAX in your IRA's to avoid the wash sales.

If you don't want to sell all VTSAX in your IRA's, then the wash sale proceeds on a share by share disallowal basis (i.e. if 10 shares were purchased, 10 shares of the loss will be disallowed, permanently for purchases in an IRA).

If purchases are more than 30 days ago, they don't count for wash sales today.

If you sell shares purchased within the past 30 days, they won't count for wash sales.

Monsterflockster
Posts: 298
Joined: Thu Nov 21, 2019 12:03 am

Re: Hoping for help on first tax loss harvesting scenario

Post by Monsterflockster » Tue Mar 24, 2020 2:43 pm

Just remember you’re not getting out of paying taxes, you’re reducing taxes now to pay more later...

travellight
Posts: 2866
Joined: Tue Aug 12, 2008 5:52 pm
Location: San Diego

Re: Hoping for help on first tax loss harvesting scenario

Post by travellight » Tue Mar 24, 2020 2:52 pm

Monsterflockster wrote:
Tue Mar 24, 2020 2:43 pm
Just remember you’re not getting out of paying taxes, you’re reducing taxes now to pay more later...
I thought that you are getting out of paying taxes on capital gains that you would've without the offset of the loss?

Of course, the hope is that the replacement choices grow tremendously and create gains that you will be taxed on in the future but I thought tax loss harvesting was a net positive and gain by reducing Taxes on gains you would have had to pay if you did not make this lane change.
364

Monsterflockster
Posts: 298
Joined: Thu Nov 21, 2019 12:03 am

Re: Hoping for help on first tax loss harvesting scenario

Post by Monsterflockster » Tue Mar 24, 2020 4:48 pm

I am assuming you read this: https://www.bogleheads.org/wiki/Tax_loss_harvesting

My understanding is that if you sell now at a loss you get to deduct the loss against capital gains or $3000 of income. However, assuming you are remaining in the market and buy a "similar but different" fund at new lower price, you will have to pay taxes on those greater gains when you sell in the future.

Example:
    You buy 10 shares at $100. Shares decrease to $50 and you sell at a $500 loss. You can deduct $500.
      You then buy 10 similar shares at $50. Over time shares increase to $150 and you sell. You are taxed on $1000 capital gains.

      If you held you would pay taxes on $500. Because you TLH you still pay $500 ($1000-$500 loss deduction). Government gets their money either way.

      I could be wrong but my understanding is that TLH is a deferment of taxes, not an escape of them.

      Topic Author
      MilitaryDoc
      Posts: 70
      Joined: Sun Jan 12, 2014 10:23 am

      Re: Hoping for help on first tax loss harvesting scenario

      Post by MilitaryDoc » Tue Mar 24, 2020 5:34 pm

      rkhusky wrote:
      Tue Mar 24, 2020 2:39 pm
      You can sell all VTSAX in your IRA's to avoid the wash sales.

      If you don't want to sell all VTSAX in your IRA's, then the wash sale proceeds on a share by share disallowal basis (i.e. if 10 shares were purchased, 10 shares of the loss will be disallowed, permanently for purchases in an IRA).

      If purchases are more than 30 days ago, they don't count for wash sales today.

      If you sell shares purchased within the past 30 days, they won't count for wash sales.
      If I exchanged all of VTSAX for VFIAX in both Roth IRAs on day 1 and then exchanged VTSAX for VLCAX and VTIAX for VFWAX on day 2, are you saying I won't have any wash sales at all?

      If I don't want to mess with the Roth IRAs and as long as I sell the VTSAX and VTIAX shares with losses including those I purchased in the last 30 days, will I only have wash sales as a result of the shares purchases (or dividends reinvested) in the Roth IRAs NOT from the taxable account transactions?

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      iceport
      Posts: 4655
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      Re: Hoping for help on first tax loss harvesting scenario

      Post by iceport » Wed Mar 25, 2020 10:44 am

      Hi MilitaryDoc,

      It's good that you're thinking about this ahead of time. A little planning for TLH can go a long way. Here are some thoughts on your questions.

      1) I agree with rkhusky, you don't have to wait for 31 days to sell shares at a loss that were purchased in the last 31 days — in the taxable account. You just need to make sure, using the Specific ID cost basis method, to sell all the recent purchases either before or in the same order as the rest of the shares being sold at a loss. (You did count wash period days correctly, though.) If the recent shares are sold after the other losing shares, you will create a partial wash sale, but there are no adverse consequences for you *in the taxable account*. That's because the disallowed loss on the sale of the wash shares gets added to the cost basis of the recent "replacement shares," and then the disallowed loss is realized and can be claimed when those replacement shares are sold.

      This leaves you with the issue of the replacement shares you purchased in your IRAs. (I'm assuming the dollar value of the replacement shares is not large, because they were only the result of reinvested dividends. And you will need to make sure there are no other regular contributions into VTSAX in the IRAs for at least 30 days after the TLH.) You have a few options. You could do nothing with the replacement shares, and report the small wash sale on the honor system. Brokers are not required to report wash sales across accounts, but taxpayers are! The disallowed loss will be gone for good, but it might not be a large enough hit to bother you much.

      Alternatively, you could, as rkhusky noted, sell all shares of VTSAX in the IRAs at least a day before you TLH in the taxable account. Folks here generally agree that will avoid a wash sale, because it's obvious that no replacement shares are left to match with losing taxable shares.

      My own opinion is that selling all shares in the IRAs is unreasonable and unnecessary to avoid a wash sale. I've made the case here, for example, that you should only be required to sell only the number of shares purchased within the wash sale period, even though you can't select exactly which shares are to be sold. In an IRA, every share is just like every other share. Cost basis and holding period are irrelevant. Most folks don't agree that this strategy is risk-free, but their logic escapes me. You would need to figure out if my argument makes sense to you, and whether you'd be willing to make the same case to the IRS in the extremely unlikely event of an audit. I certainly would, but you must decide for yourself.


      Your substitute funds are excellent choices. As you seem to realize already, if the market rebounds in the next 30 days, you might be "stuck" in the substitute funds indefinitely if you don't want to realize capital gains that would offset your loss harvest. As for timing, it's always advisable to take the opportunity to TLH when it arises, because you don't know how long it will last. (This opportunity could last a long while, or not, we just don't know.)

      2) Wash sales are not all-or-nothing. As rkhusky noted, shares sold at a loss are matched, share by share, with "replacement shares," i.e. substantially identical shares bought within the 61-day wash sale period. The loss on only the sold shares matched this way with replacement shares will be disallowed. When you run out of replacement shares to match with losing shares sold, the rest of the sale is not a wash, and the rest of the losses will be allowed.

      In the case of replacement shares in a taxable account, the loss on the wash shares is added to the cost basis of the replacement shares, and that loss will finally be realized when those replacement shares are sold. If the replacement shares are in a tax-advantaged account, there can be no meaningful cost basis adjustment, so the disallowed loss is gone forever.

      Banking a large loss all at once is a great way to reduce ordinary income for many years to come.

      3) Yes, you have that right.

      4) I don't think you will need to worry about the 6 month rule, because your funds don't produce tax-exempt interest or even distribute capital gains. (No capital gains distributions is one of the advantages of using a well-managed index fund in a taxable account. Vanguard is one of the best at maintaining tax-efficiency of its index funds.)


      One final note... Because you are planning ahead and thinking this through appropriately, I think you would benefit from reading the first five of the unusually clear and concise explanations of the nuances of wash sales over at Fairmark.com, listed on this header page: The Wash Sale Rule. It'll only take about half an hour, and you will probably gain far more confidence in the process.

      Another great resource is this blog entry from PhysicianonFire: Tax Loss Harvesting with Vanguard: A Step by Step Guide.
      "Discipline matters more than allocation.” ─William Bernstein

      User avatar
      iceport
      Posts: 4655
      Joined: Sat Apr 07, 2007 4:29 pm

      Re: Hoping for help on first tax loss harvesting scenario

      Post by iceport » Wed Mar 25, 2020 10:49 am

      Monsterflockster wrote:
      Tue Mar 24, 2020 4:48 pm
      I am assuming you read this: https://www.bogleheads.org/wiki/Tax_loss_harvesting

      My understanding is that if you sell now at a loss you get to deduct the loss against capital gains or $3000 of income. However, assuming you are remaining in the market and buy a "similar but different" fund at new lower price, you will have to pay taxes on those greater gains when you sell in the future.

      Example:
        You buy 10 shares at $100. Shares decrease to $50 and you sell at a $500 loss. You can deduct $500.
          You then buy 10 similar shares at $50. Over time shares increase to $150 and you sell. You are taxed on $1000 capital gains.

          If you held you would pay taxes on $500. Because you TLH you still pay $500 ($1000-$500 loss deduction). Government gets their money either way.

          I could be wrong but my understanding is that TLH is a deferment of taxes, not an escape of them.
          You math is correct, but what you're missing is that by using the losses to offset ordinary income, you effectively turn your income tax rate into your (presumably lower) capital gains tax rate, for the $3k/year/person of ordinary income. Also, for any shares passed on to heirs or donated to charity, the capital gains taxes won't ever need to be paid.
          "Discipline matters more than allocation.” ─William Bernstein

          Topic Author
          MilitaryDoc
          Posts: 70
          Joined: Sun Jan 12, 2014 10:23 am

          Re: Hoping for help on first tax loss harvesting scenario

          Post by MilitaryDoc » Wed Mar 25, 2020 3:14 pm

          iceport wrote:
          Wed Mar 25, 2020 10:44 am
          Hi MilitaryDoc,

          It's good that you're thinking about this ahead of time. A little planning for TLH can go a long way. Here are some thoughts on your questions.

          1) I agree with rkhusky, you don't have to wait for 31 days to sell shares at a loss that were purchased in the last 31 days — in the taxable account. You just need to make sure, using the Specific ID cost basis method, to sell all the recent purchases either before or in the same order as the rest of the shares being sold at a loss. (You did count wash period days correctly, though.) If the recent shares are sold after the other losing shares, you will create a partial wash sale, but there are no adverse consequences for you *in the taxable account*. That's because the disallowed loss on the sale of the wash shares gets added to the cost basis of the recent "replacement shares," and then the disallowed loss is realized and can be claimed when those replacement shares are sold.

          This leaves you with the issue of the replacement shares you purchased in your IRAs. (I'm assuming the dollar value of the replacement shares is not large, because they were only the result of reinvested dividends. And you will need to make sure there are no other regular contributions into VTSAX in the IRAs for at least 30 days after the TLH.) You have a few options. You could do nothing with the replacement shares, and report the small wash sale on the honor system. Brokers are not required to report wash sales across accounts, but taxpayers are! The disallowed loss will be gone for good, but it might not be a large enough hit to bother you much.

          Alternatively, you could, as rkhusky noted, sell all shares of VTSAX in the IRAs at least a day before you TLH in the taxable account. Folks here generally agree that will avoid a wash sale, because it's obvious that no replacement shares are left to match with losing taxable shares.

          My own opinion is that selling all shares in the IRAs is unreasonable and unnecessary to avoid a wash sale. I've made the case here, for example, that you should only be required to sell only the number of shares purchased within the wash sale period, even though you can't select exactly which shares are to be sold. In an IRA, every share is just like every other share. Cost basis and holding period are irrelevant. Most folks don't agree that this strategy is risk-free, but their logic escapes me. You would need to figure out if my argument makes sense to you, and whether you'd be willing to make the same case to the IRS in the extremely unlikely event of an audit. I certainly would, but you must decide for yourself.


          Your substitute funds are excellent choices. As you seem to realize already, if the market rebounds in the next 30 days, you might be "stuck" in the substitute funds indefinitely if you don't want to realize capital gains that would offset your loss harvest. As for timing, it's always advisable to take the opportunity to TLH when it arises, because you don't know how long it will last. (This opportunity could last a long while, or not, we just don't know.)

          2) Wash sales are not all-or-nothing. As rkhusky noted, shares sold at a loss are matched, share by share, with "replacement shares," i.e. substantially identical shares bought within the 61-day wash sale period. The loss on only the sold shares matched this way with replacement shares will be disallowed. When you run out of replacement shares to match with losing shares sold, the rest of the sale is not a wash, and the rest of the losses will be allowed.

          In the case of replacement shares in a taxable account, the loss on the wash shares is added to the cost basis of the replacement shares, and that loss will finally be realized when those replacement shares are sold. If the replacement shares are in a tax-advantaged account, there can be no meaningful cost basis adjustment, so the disallowed loss is gone forever.

          Banking a large loss all at once is a great way to reduce ordinary income for many years to come.

          3) Yes, you have that right.

          4) I don't think you will need to worry about the 6 month rule, because your funds don't produce tax-exempt interest or even distribute capital gains. (No capital gains distributions is one of the advantages of using a well-managed index fund in a taxable account. Vanguard is one of the best at maintaining tax-efficiency of its index funds.)


          One final note... Because you are planning ahead and thinking this through appropriately, I think you would benefit from reading the first five of the unusually clear and concise explanations of the nuances of wash sales over at Fairmark.com, listed on this header page: The Wash Sale Rule. It'll only take about half an hour, and you will probably gain far more confidence in the process.

          Another great resource is this blog entry from PhysicianonFire: Tax Loss Harvesting with Vanguard: A Step by Step Guide.
          Thank you, iceport, for breaking this all down for me and offering some references. I appreciate all the replies thus far. I agree with your logic in regards to selling part or all Roth IRA shares before TLH. However, I also believe there is a small risk because the IRS may not make a favorable ruling even though your reasoning is sound and your intent is ethical.

          Would the following scenario be adequate to avoid all wash sales?
          Day 1- exchange all of VTSAX for VFIAX in both Roth IRAs Day 2- use spec ID to sell all shares with loses including all the ones purchased in the last 30 days (VTSAX for VLCAX and VTIAX for VFWAX)

          User avatar
          iceport
          Posts: 4655
          Joined: Sat Apr 07, 2007 4:29 pm

          Re: Hoping for help on first tax loss harvesting scenario

          Post by iceport » Wed Mar 25, 2020 3:37 pm

          MilitaryDoc wrote:
          Wed Mar 25, 2020 3:14 pm
          Thank you, iceport, for breaking this all down for me and offering some references. I appreciate all the replies thus far. I agree with your logic in regards to selling part or all Roth IRA shares before TLH. However, I also believe there is a small risk because the IRS may not make a favorable ruling even though your reasoning is sound and your intent is ethical.

          Would the following scenario be adequate to avoid all wash sales?
          Day 1- exchange all of VTSAX for VFIAX in both Roth IRAs Day 2- use spec ID to sell all shares with loses including all the ones purchased in the last 30 days (VTSAX for VLCAX and VTIAX for VFWAX)
          Looks good from here! :beer Note that you are free to harvest the VTIAX loss anytime. You don't need to wait for Day 2.

          Good planning to use a different substitute fund for VTSAX in the IRAs; I noticed that detail.

          I'm glad you are assuming personal responsibility for your actions, and I support your caution, even if I don't share it. (I also want to thank you for your assessment of my logic, because sometimes it seems like I'm banging my head against the wall... :| )
          "Discipline matters more than allocation.” ─William Bernstein

          Topic Author
          MilitaryDoc
          Posts: 70
          Joined: Sun Jan 12, 2014 10:23 am

          Re: Hoping for help on first tax loss harvesting scenario

          Post by MilitaryDoc » Wed Mar 25, 2020 4:20 pm

          iceport wrote:
          Wed Mar 25, 2020 3:37 pm
          Looks good from here! :beer Note that you are free to harvest the VTIAX loss anytime. You don't need to wait for Day 2.

          Good planning to use a different substitute fund for VTSAX in the IRAs; I noticed that detail.

          I'm glad you are assuming personal responsibility for your actions, and I support your caution, even if I don't share it. (I also want to thank you for your assessment of my logic, because sometimes it seems like I'm banging my head against the wall... :| )
          Yes, I could execute the TLH on VTIAX sooner. Thanks for reminding me of that and validating my plan.

          I think my TLH replacement funds (VFWAX and VLCAX) also aren’t going to be substantially identical to initial funds in all taxable, IRA, and TSP accounts (VTSAX, VTIAX, S, C, F, or G funds). And yes, I made sure not to switch over to my planned alternate fund in the Roth IRAs before making the TLH transactions in the taxable account.

          Can I add more shares to the alternate funds within 30 days after the TLH if I want?

          :sharebeer

          User avatar
          iceport
          Posts: 4655
          Joined: Sat Apr 07, 2007 4:29 pm

          Re: Hoping for help on first tax loss harvesting scenario

          Post by iceport » Wed Mar 25, 2020 4:31 pm

          MilitaryDoc wrote:
          Wed Mar 25, 2020 4:20 pm

          Can I add more shares to the alternate funds within 30 days after the TLH if I want?
          Sure. Just be aware, that means if we get more precipitous declines after that, you'd need to sell those recent purchases to avoid a wash sale in any subsequent TLH endeavor within 30 days of the purchase(s). (They'd most likely have losses to harvest anyway, in that case.)

          You just can't buy any more of the funds with harvested losses within the 30 days.
          "Discipline matters more than allocation.” ─William Bernstein

          DA200
          Posts: 219
          Joined: Fri Feb 06, 2015 3:47 pm

          Re: Hoping for help on first tax loss harvesting scenario

          Post by DA200 » Wed Mar 25, 2020 8:29 pm

          MilitaryDoc,
          Since you are carefully studying tax loss harvesting rules, you should also make sure you clearly understand rules related to treatment of Dividends as Qualified vs Ordinary (which changes tax rates). Here is the rule which you should understand while implementing tax loss harvesting strategies.

          Qualified dividends and ordinary dividends have different holding period requirements for taxes and different dividend tax rates, which can affect your tax rate. It is important to know the difference in dividends, so that you know how to minimize taxes. For common stocks and mutual funds the shares must be held for more than 60 days during a 121-day period that begins 60 days before the ex-dividend date to treat the dividends as qualified.

          This issue is often overlooked during tax loss harvesting events. If you purchase a fund before the ex dividend date and sell after the ex dividend date (but don’t hold the fund for 60 days before selling), the dividend will be taxed at the higher ordinary dividend rate. Many individuals don’t take this into account when switching back to their original investment only 30 days after a tax loss harvesting event. This happened to many back in December 2018 when the market dropped around the same time that many mutual funds have large dividend distributions (mid December). Some funds only pay dividends once or twice a year, others pay quarterly. Keep track of the ex div date for the mutual fund you are planning to use as a tax loss harvesting partner. If this ex div date occurs in the 30 day window you will hold the fund, you may need to find a different fund partner, or remember to hold for 60 days (not 30 days).

          Topic Author
          MilitaryDoc
          Posts: 70
          Joined: Sun Jan 12, 2014 10:23 am

          Re: Hoping for help on first tax loss harvesting scenario

          Post by MilitaryDoc » Wed Mar 25, 2020 11:00 pm

          DA200 wrote:
          Wed Mar 25, 2020 8:29 pm
          MilitaryDoc,
          Since you are carefully studying tax loss harvesting rules, you should also make sure you clearly understand rules related to treatment of Dividends as Qualified vs Ordinary (which changes tax rates). Here is the rule which you should understand while implementing tax loss harvesting strategies.

          Qualified dividends and ordinary dividends have different holding period requirements for taxes and different dividend tax rates, which can affect your tax rate. It is important to know the difference in dividends, so that you know how to minimize taxes. For common stocks and mutual funds the shares must be held for more than 60 days during a 121-day period that begins 60 days before the ex-dividend date to treat the dividends as qualified.

          This issue is often overlooked during tax loss harvesting events. If you purchase a fund before the ex dividend date and sell after the ex dividend date (but don’t hold the fund for 60 days before selling), the dividend will be taxed at the higher ordinary dividend rate. Many individuals don’t take this into account when switching back to their original investment only 30 days after a tax loss harvesting event. This happened to many back in December 2018 when the market dropped around the same time that many mutual funds have large dividend distributions (mid December). Some funds only pay dividends once or twice a year, others pay quarterly. Keep track of the ex div date for the mutual fund you are planning to use as a tax loss harvesting partner. If this ex div date occurs in the 30 day window you will hold the fund, you may need to find a different fund partner, or remember to hold for 60 days (not 30 days).
          DA200,

          You bring up a great point, which I assume is often overlooked. In fact, I recall glossing over this aspect when reading about TLH. Thanks for clearly explaining it. Both VTSAX and VTIAX pay dividends quarterly. They both pay out now. VTIAX just did within the past week, and I think VTSAX may be tomorrow. Thus, I won't be TLH until right after their dividend dates.

          If I understand you correctly, I should have qualified dividends if I hold them for 60 days before selling them on the 61st day if I so choose. Does this sound right?
          Would this nuance be a moot point if my harvested losses exceed my expected 2020 dividends and capital gains?

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