Can I create tax losses with short/long ETF positions?

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soupcxan
Posts: 212
Joined: Tue Apr 14, 2009 8:54 am

Can I create tax losses with short/long ETF positions?

Post by soupcxan »

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Last edited by soupcxan on Sun Dec 10, 2017 2:16 pm, edited 1 time in total.
delamer
Posts: 17458
Joined: Tue Feb 08, 2011 5:13 pm

Re: Can I create tax losses with short/long ETF positions?

Post by delamer »

They both go down.
One thing that humbles me deeply is to see that human genius has its limits while human stupidity does not. - Alexandre Dumas, fils
bberris
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Joined: Sun Feb 20, 2011 8:44 am

Re: Can I create tax losses with short/long ETF positions?

Post by bberris »

This runs afoul of a general IRS rule called "economic substance". A transaction whose only purpose is to reduce taxes would disallow the tax loss. This might be fraud as well. Since you expect the return to be zero, this would fall under that rule.

Note that you would also have to constantly rebalance the position to keep the risk down, adding to your transaction costs. Finally, you would only be able to shelter $3,000 per year this way.
NYC_Guy
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Location: New York

Re: Can I create tax losses with short/long ETF positions?

Post by NYC_Guy »

bberris wrote:This runs afoul of a general IRS rule called "economic substance". A transaction whose only purpose is to reduce taxes would disallow the tax loss. This might be fraud as well. Since you expect the return to be zero, this would fall under that rule.

Note that you would also have to constantly rebalance the position to keep the risk down, adding to your transaction costs. Finally, you would only be able to shelter $3,000 per year this way.
Here's what would be ok. Short GM and go long on Ford. Maintain an overall neutral position. Harvest your loss at the appropriate time. The wash-sale rules would keep you out of the realized loss position for 30 days. And during that time you have an unbalanced position. Although you could use another stock (in the old days, Chrysler) as a proxy.

The IRS rules were written for a by-gone age. ETFs don't fit neatly into the rules. Correlation between different indices can be super high. And the IRS and the courts haven't given us much guidance about how to deal with this stuff. So proceed at your own risk.
Wagnerjb
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Location: Houston, Texas

Re: Can I create tax losses with short/long ETF positions?

Post by Wagnerjb »

soupcxan wrote: Risks:
1. Basis risk between the two funds - if one goes down more than the other goes up, I lose.
2. Low volatility - if market is mostly flat, I've wasted my time (but not lost any money)

One more risk - a strongly rising market. If the market goes up 35%, you have guaranteed yourself a 0% return. Just one year of that, and you will have lost a lot more than the value of the tax losses you generated.

A more minor note.....the beginning of year 2 (and every year going forward) gets sloppy for you. When you sell the loser in December, you have to wait 30 days before you can repurchase....so you are naked for 30 days.

Best wishes.
Andy
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