ETF - open secret - cap gains tax loophole
ETF - open secret - cap gains tax loophole
Just saw this article - had not really thought much about the ETF taxing world -
http://www.investopedia.com/news/etf-op ... yptr=yahoo
According to a 2010 report by the Kauffman Foundation, exchange-traded funds (ETFs) were invented to avoid the "confiscatory tax policy" that individual investors in mutual funds must endure. These investors pay capital gains tax on sales of securities held by the fund, with occasionaly wrenching consequences. During the financial crisis, mutual funds were forced to sell some of their holdings to honor redemptions; these generated capital gains taxes, meaning that investors had to pay tax on assets that had fallen sharply in value.
ETFs, on the other hand, don't subject their investors to such harsh tax treatment. ETF providers offer shares "in kind," with authorized participants serving as a buffer between investors and the providers' trading-triggered tax events. No wonder the vehicle has become so popular, with assets in U.S.-listed ETFs and exchange-traded notes (ETNs) ballooining from $71 billion in 2000 to $2.7 trillion in February 2017.
http://www.investopedia.com/news/etf-op ... yptr=yahoo
According to a 2010 report by the Kauffman Foundation, exchange-traded funds (ETFs) were invented to avoid the "confiscatory tax policy" that individual investors in mutual funds must endure. These investors pay capital gains tax on sales of securities held by the fund, with occasionaly wrenching consequences. During the financial crisis, mutual funds were forced to sell some of their holdings to honor redemptions; these generated capital gains taxes, meaning that investors had to pay tax on assets that had fallen sharply in value.
ETFs, on the other hand, don't subject their investors to such harsh tax treatment. ETF providers offer shares "in kind," with authorized participants serving as a buffer between investors and the providers' trading-triggered tax events. No wonder the vehicle has become so popular, with assets in U.S.-listed ETFs and exchange-traded notes (ETNs) ballooining from $71 billion in 2000 to $2.7 trillion in February 2017.
Re: ETF - open secret - cap gains tax loophole
I always wondered how IRS kept track of old CG, when specific identification is chosen, pre-2012...
- triceratop
- Posts: 5838
- Joined: Tue Aug 04, 2015 8:20 pm
- Location: la la land
Re: ETF - open secret - cap gains tax loophole
This is an irresponsible article in several ways.
(1) While ETF may have tax advantages, and may even have been created with these advantages in mind, it is not the case that "individual investors in mutual funds must endure" such disadvantages. As is well-discussed and -documented, Vanguard mutual funds do not have such disadvantages relative to the ETF shareholders of the same fund.
(2) The article discusses the uses of ETFs for executing tax fraud/evasion (using S&P500 index funds from different providers while relying on the IRS being asleep and never noticing and arguing that these are substantially identical securities), while ignoring the very legitimate tax avoidance means of using ETFs (and mutual funds) for essentially the same effect: S&P500 and a Large Cap index behave similarly but not identically. And this almost looks like a misquote, given the missing context:
(1) While ETF may have tax advantages, and may even have been created with these advantages in mind, it is not the case that "individual investors in mutual funds must endure" such disadvantages. As is well-discussed and -documented, Vanguard mutual funds do not have such disadvantages relative to the ETF shareholders of the same fund.
(2) The article discusses the uses of ETFs for executing tax fraud/evasion (using S&P500 index funds from different providers while relying on the IRS being asleep and never noticing and arguing that these are substantially identical securities), while ignoring the very legitimate tax avoidance means of using ETFs (and mutual funds) for essentially the same effect: S&P500 and a Large Cap index behave similarly but not identically. And this almost looks like a misquote, given the missing context:
There are legitimate tax harvesting strategies which may justify some fee level (but probably not the fee level being charged) and which is not illegal. The government perfectly well understands how people are using similar funds to tax loss harvest.Bradley is not so sure, though. "High net worth people don't have any interest in having the government understand" the loophole, which he says is "I think the biggest driver of ETF adoption by financial planners. Period. They can justify their fees based on their 'tax harvesting strategies.'"
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."
- triceratop
- Posts: 5838
- Joined: Tue Aug 04, 2015 8:20 pm
- Location: la la land
Re: ETF - open secret - cap gains tax loophole
You are responsible for reporting accurate cost basis on non-covered shares. You may be audited and be required to prove what you claim the cost basis was. Reporting incorrect information is illegal (and discussion of such is against forum rules by the way).Thesaints wrote:I always wondered how IRS kept track of old CG, when specific identification is chosen, pre-2012...
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."
Re: ETF - open secret - cap gains tax loophole
I'm not discussing, nor suggesting. Besides, the linked article is about people (apparently a large number of them) skirting the wash sale rule, which is not any more legal, especially in the example provided of two S&P500 ETF's issued by different companies.triceratop wrote:You are responsible for reporting accurate cost basis on non-covered shares. You may be audited and be required to prove what you claim the cost basis was. Reporting incorrect information is illegal (and discussion of such is against forum rules by the way).Thesaints wrote:I always wondered how IRS kept track of old CG, when specific identification is chosen, pre-2012...
Re: ETF - open secret - cap gains tax loophole
The substantially identical determination is actually a grey area and the IRS has not found univocally one way or another. This often comes up with investors writing DITM calls on an ETF slightly different from their holdings.triceratop wrote:This is an irresponsible article in several ways.
(1) While ETF may have tax advantages, and may even have been created with these advantages in mind, it is not the case that "individual investors in mutual funds must endure" such disadvantages. As is well-discussed and -documented, Vanguard mutual funds do not have such disadvantages relative to the ETF shareholders of the same fund.
(2) The article discusses the uses of ETFs for executing tax fraud/evasion (using S&P500 index funds from different providers while relying on the IRS being asleep and never noticing and arguing that these are substantially identical securities), while ignoring the very legitimate tax avoidance means of using ETFs (and mutual funds) for essentially the same effect: S&P500 and a Large Cap index behave similarly but not identically. And this almost looks like a misquote, given the missing context:
There are legitimate tax harvesting strategies which may justify some fee level (but probably not the fee level being charged) and which is not illegal. The government perfectly well understands how people are using similar funds to tax loss harvest.Bradley is not so sure, though. "High net worth people don't have any interest in having the government understand" the loophole, which he says is "I think the biggest driver of ETF adoption by financial planners. Period. They can justify their fees based on their 'tax harvesting strategies.'"
Re: ETF - open secret - cap gains tax loophole
This article provides no evidence that anyone has ever used this technique. Why would someone possibly risk having the TLH disallowed when TLHing between S&500 and a Large Cap index would give one nearly the same results?triceratop wrote: (2) The article discusses the uses of ETFs for executing tax fraud/evasion (using S&P500 index funds from different providers while relying on the IRS being asleep and never noticing and arguing that these are substantially identical securities), while ignoring the very legitimate tax avoidance means of using ETFs (and mutual funds) for essentially the same effect: S&P500 and a Large Cap index behave similarly but not identically. And this almost looks like a misquote, given the missing context:
As an aside, if one fund used a full replication strategy and another used sampling, I doubt they would be substantially identical.
Re: ETF - open secret - cap gains tax loophole
Not looking at the taxing strategy card tricks - but merely at the main point of Mutual Fund vs ETF taxes with respect to Cap Gains.triceratop wrote:This is an irresponsible article in several ways.
(1) While ETF may have tax advantages, and may even have been created with these advantages in mind, it is not the case that "individual investors in mutual funds must endure" such disadvantages. As is well-discussed and -documented, Vanguard mutual funds do not have such disadvantages relative to the ETF shareholders of the same fund.
In recent years I have had a large amount of Cap Gains reported from my mutual funds.
Does the ETF versions then not have these same Cap Gains reported back to users via a 1099...
I only have a few ETFs, and don't recall seeing a 1099 reflecting any Cap Gains for those holdings - - [could be wrong, will have to go look]
Isn't that the whole point - to NOT have the Cap Gains reported back to you....
and it appears the ETFs do just that, while mutual funds generate the Cap Gains, and the 1099s - so.... are ETFs better in this case ?
Last edited by ps56k on Mon Jul 10, 2017 11:12 am, edited 2 times in total.
Re: ETF - open secret - cap gains tax loophole
did I miss a PLR from the IRS or is this your tax advice / interpretation? I haven't heard of any audits related to this either. If you have, I'm sure we'd be happy to hear about them.triceratop wrote:(2) The article discusses the uses of ETFs for executing tax fraud/evasion (using S&P500 index funds from different providers while relying on the IRS being asleep and never noticing and arguing that these are substantially identical securities)...
There are a number of differences between ETFs tracking the same or similar indexes, including voting rights, investment methodology, securities lending, etc. Whether those are substantial in the IRS's eyes is an open question as far as I've read.
Last edited by Tanelorn on Mon Jul 10, 2017 11:09 am, edited 1 time in total.
Re: ETF - open secret - cap gains tax loophole
ETF's do not distribute capital gains.ps56k wrote:Not looking at the taxing strategy card tricks - but merely at the main point of Mutual Fund vs ETF taxes with respect to Cap Gains.triceratop wrote:This is an irresponsible article in several ways.
(1) While ETF may have tax advantages, and may even have been created with these advantages in mind, it is not the case that "individual investors in mutual funds must endure" such disadvantages. As is well-discussed and -documented, Vanguard mutual funds do not have such disadvantages relative to the ETF shareholders of the same fund.
In recent years I have had a large amount of Cap Gains reported from my mutual funds.
Does the ETF versions then not have these same Cap Gains reported back to users via a 1099...
I only have a few ETFs, and don't recall seeing a 1099 - -
- triceratop
- Posts: 5838
- Joined: Tue Aug 04, 2015 8:20 pm
- Location: la la land
Re: ETF - open secret - cap gains tax loophole
I am aware of the lack of IRS guidance. That does not mean those intentionally violating the intent and spirit of the law are free and clear, because the IRS could choose to begin enforcing this (and end up in tax court eventually, I would venture to guess).Thesaints wrote:The substantially identical determination is actually a grey area and the IRS has not found univocally one way or another. This often comes up with investors writing DITM calls on an ETF slightly different from their holdings.triceratop wrote:This is an irresponsible article in several ways.
(1) While ETF may have tax advantages, and may even have been created with these advantages in mind, it is not the case that "individual investors in mutual funds must endure" such disadvantages. As is well-discussed and -documented, Vanguard mutual funds do not have such disadvantages relative to the ETF shareholders of the same fund.
(2) The article discusses the uses of ETFs for executing tax fraud/evasion (using S&P500 index funds from different providers while relying on the IRS being asleep and never noticing and arguing that these are substantially identical securities), while ignoring the very legitimate tax avoidance means of using ETFs (and mutual funds) for essentially the same effect: S&P500 and a Large Cap index behave similarly but not identically. And this almost looks like a misquote, given the missing context:
There are legitimate tax harvesting strategies which may justify some fee level (but probably not the fee level being charged) and which is not illegal. The government perfectly well understands how people are using similar funds to tax loss harvest.Bradley is not so sure, though. "High net worth people don't have any interest in having the government understand" the loophole, which he says is "I think the biggest driver of ETF adoption by financial planners. Period. They can justify their fees based on their 'tax harvesting strategies.'"
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."
Re: ETF - open secret - cap gains tax loophole
Incorrect.Thesaints wrote:ETF's do not distribute capital gains.
http://news.morningstar.com/articlenet/ ... ?id=268269
Particularly standing out was Rydex Inverse 2x S&P Select Sector Energy (REC), which paid out a short-term capital gains distribution equal to about 74% of the fund's NAV.
Last edited by Tanelorn on Mon Jul 10, 2017 11:12 am, edited 1 time in total.
- triceratop
- Posts: 5838
- Joined: Tue Aug 04, 2015 8:20 pm
- Location: la la land
Re: ETF - open secret - cap gains tax loophole
I thought it was clear from my post in the full, non-boldfaced context, that the IRS still has not provided any guidance here: "relying on the IRS being asleep and never noticing". What my post is about is the risk that the IRS chooses to begin enforcement.Tanelorn wrote:did I miss a PLR from the IRS or is this your tax advice / interpretation? I haven't heard of any audits related to this either. If you have, I'm sure we'd be happy to hear about them.triceratop wrote:(2) The article discusses the uses of ETFs for executing tax fraud/evasion (using S&P500 index funds from different providers while relying on the IRS being asleep and never noticing and arguing that these are substantially identical securities)...
There are a number of differences between ETFs tracking the same or similar indexes, including voting rights, investment methodology, securities lending, etc. Whether those are substantial in the IRS's eyes is an open question as far as I've read.
edit: anyway, my point is not what I personally believe the correct interpretation of tax law is, it is what the author believes. The rest of my statement is about leaving out critical information about better ways to tax loss harvest.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."
Re: ETF - open secret - cap gains tax loophole
Just took a look at my Vanguard 1099 from last year -
mostly ALL of it is reflected in DIVS - with no real Box2a Cap Gains.... so, no big deal compared to their ETF (if they exist)
Also - for my Schwab investing brokerage account - stocks and ETFs - there were no Cap Gains reported at all.... as expected -
------- Cap Gains - Box 2a
Tot Intl Bond Adm - $0
Wellesley Adm - $823
Long Term Invest Adm - $1,116
Tot Intl Stock Adm - $0
Tot Bond Adm - $11
Tot Stock Adm - $0
Windsor Adm - $7,814
Mid Cap Adm - $0
mostly ALL of it is reflected in DIVS - with no real Box2a Cap Gains.... so, no big deal compared to their ETF (if they exist)
Also - for my Schwab investing brokerage account - stocks and ETFs - there were no Cap Gains reported at all.... as expected -
------- Cap Gains - Box 2a
Tot Intl Bond Adm - $0
Wellesley Adm - $823
Long Term Invest Adm - $1,116
Tot Intl Stock Adm - $0
Tot Bond Adm - $11
Tot Stock Adm - $0
Windsor Adm - $7,814
Mid Cap Adm - $0
Last edited by ps56k on Mon Jul 10, 2017 11:27 am, edited 1 time in total.
- triceratop
- Posts: 5838
- Joined: Tue Aug 04, 2015 8:20 pm
- Location: la la land
Re: ETF - open secret - cap gains tax loophole
This is not surprising. It's also unique to Vanguard, for now. Read this link: https://www.bogleheads.org/wiki/ETFs_vs ... uard_fundsps56k wrote:Just took a look at my Vanguard 1099 from last year -
mostly ALL of it is reflected in DIVS - with no real Box2a Cap Gains.... so, no big deal compared to their ETF (if they exist)
------- Cap Gains - Box 2a
Tot Intl Bond Adm - $0
Wellesley Adm - $823
Long Term Invest Adm - $1,116
Tot Intl Stock Adm - $0
Tot Bond Adm - $11
Tot Stock Adm - $0
Windsor Adm - $7,814
Mid Cap Adm - $0
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."
Re: ETF - open secret - cap gains tax loophole
yes - read the link you had posted up above... but didn't quite grasp what it was saying -triceratop wrote:This is not surprising. It's also unique to Vanguard, for now.
Read this link: https://www.bogleheads.org/wiki/ETFs_vs ... uard_funds
Vanguard ETFs are structured as another share class of a mutual fund, like Admiral or Investor shares. This is a process unique to Vanguard, protected by a patent until 2023, with two important consequences for the mutual fund investor:
Tax efficiency: the mutual fund shares benefit from the disposition of capital gains through ETF shares, making Vanguard funds with ETF share classes as efficient as an ETF.
-
- Posts: 3908
- Joined: Fri Jan 17, 2014 9:19 am
Re: ETF - open secret - cap gains tax loophole
For similar funds, Fidelity funds distributed more capital gains than Vanguard funds.
Re: ETF - open secret - cap gains tax loophole
Sure "inverse" being the key. Which retail investor buys those ?Tanelorn wrote:Incorrect.Thesaints wrote:ETF's do not distribute capital gains.
http://news.morningstar.com/articlenet/ ... ?id=268269Particularly standing out was Rydex Inverse 2x S&P Select Sector Energy (REC), which paid out a short-term capital gains distribution equal to about 74% of the fund's NAV.
- triceratop
- Posts: 5838
- Joined: Tue Aug 04, 2015 8:20 pm
- Location: la la land
Re: ETF - open secret - cap gains tax loophole
Not the point. Tanelorn used that because it is an extreme example. If you're making a universal claim about the tax structure of ETFs you only need one counterexample. Anyway, you can as easily use BND which regularly distributes capital gains.Thesaints wrote:Sure "inverse" being the key. Which retail investor buys those ?Tanelorn wrote:Incorrect.Thesaints wrote:ETF's do not distribute capital gains.
http://news.morningstar.com/articlenet/ ... ?id=268269Particularly standing out was Rydex Inverse 2x S&P Select Sector Energy (REC), which paid out a short-term capital gains distribution equal to about 74% of the fund's NAV.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."
Re: ETF - open secret - cap gains tax loophole
Sorry, I was assuming stock ETF's because of the thread we are in.triceratop wrote:Not the point. Tanelorn used that because it is an extreme example. If you're making a universal claim about the tax structure of ETFs you only need one counterexample. Anyway, you can as easily use BND which regularly distributes capital gains.Thesaints wrote:Sure "inverse" being the key. Which retail investor buys those ?Tanelorn wrote:Incorrect.Thesaints wrote:ETF's do not distribute capital gains.
http://news.morningstar.com/articlenet/ ... ?id=268269Particularly standing out was Rydex Inverse 2x S&P Select Sector Energy (REC), which paid out a short-term capital gains distribution equal to about 74% of the fund's NAV.
- triceratop
- Posts: 5838
- Joined: Tue Aug 04, 2015 8:20 pm
- Location: la la land
Re: ETF - open secret - cap gains tax loophole
VSS has distributed capital gains.Thesaints wrote:Sorry, I was assuming stock ETF's because of the thread we are in.triceratop wrote:Not the point. Tanelorn used that because it is an extreme example. If you're making a universal claim about the tax structure of ETFs you only need one counterexample. Anyway, you can as easily use BND which regularly distributes capital gains.Thesaints wrote:Sure "inverse" being the key. Which retail investor buys those ?Tanelorn wrote:Incorrect.Thesaints wrote:ETF's do not distribute capital gains.
http://news.morningstar.com/articlenet/ ... ?id=268269Particularly standing out was Rydex Inverse 2x S&P Select Sector Energy (REC), which paid out a short-term capital gains distribution equal to about 74% of the fund's NAV.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."
Re: ETF - open secret - cap gains tax loophole
By and large a stock ETF does not distribute gains, as it is only an accounting intermediary between those supplying ETF shares by providing the required securities basket and those reedeming ETF shares, who obtain securities in exchange.
As such all the ETF transactions are in-kind redemption, which do not generate taxable capital gains.
If they do distribute gains, it is due only to special situations.
Different is the case of bond ETF, where the basket is continuously changing due to bond approaching maturity. Thus the mechanism of creation/redemption takes place with a continuosly variable basket of securities.
As such all the ETF transactions are in-kind redemption, which do not generate taxable capital gains.
If they do distribute gains, it is due only to special situations.
Different is the case of bond ETF, where the basket is continuously changing due to bond approaching maturity. Thus the mechanism of creation/redemption takes place with a continuosly variable basket of securities.
Re: ETF - open secret - cap gains tax loophole
I haven't read the Kauffman Foundation report but the statement above is blatantly incorrect. ETFs were invented because the SEC asked for someone to invent them and hinted that they would provide expedited approval.ps56k wrote:According to a 2010 report by the Kauffman Foundation, exchange-traded funds (ETFs) were invented to avoid the "confiscatory tax policy" that individual investors in mutual funds must endure.
The SEC wanted to provide more liquidity to prevent a recurrence of the 1987 crash, provided an outline of what they thought ETFs should be like, and then financial firms raced to build a new "product" to sell to their customers.The AMEX team dropped everything else and dove in. “We were essentially reverse-engineering what the SEC called for in their report,” Bloom says. “We viewed it as a product proposal being made by the regulators.”
https://www.bloomberg.com/features/2016-etf-files/
- triceratop
- Posts: 5838
- Joined: Tue Aug 04, 2015 8:20 pm
- Location: la la land
Re: ETF - open secret - cap gains tax loophole
To be clear, I'm as big a proponent of ETFs for their tax advantages as anyone. All my investments are in ETFs.Thesaints wrote:By and large a stock ETF does not distribute gains, as it is only an accounting intermediary between those supplying ETF shares by providing the required securities basket and those reedeming ETF shares, who obtain securities in exchange.
As such all the ETF transactions are in-kind redemption, which do not generate taxable capital gains.
If they do distribute gains, it is due only to special situations.
Different is the case of bond ETF, where the basket is continuously changing due to bond approaching maturity. Thus the mechanism of creation/redemption takes place with a continuosly variable basket of securities.
But we started from "ETF's do not distribute capital gains" and proceeded to "Stock ETFs do not distribute capital gains" and then "by and large stock ETFs do not distribute capital gains". That last statement I actually agree with!
There actually wasn't much special about the circumstances leading to VSS distributing a gain. It simply began trading essentially at the bottom of the 2008 crash's market, and so there weren't any shares with losses to redeem.
I just want people to have the correct expectations when it comes to tax effects of investing with ETFs. Overly broad statements do not help with that.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."
Re: ETF - open secret - cap gains tax loophole
I read some opinion in the past that suggested just having different Board of Directors might be enough to make tow funds/etfs substantially identical.TIAX wrote:As an aside, if one fund used a full replication strategy and another used sampling, I doubt they would be substantially identical.
Selling a security and buy a call for the same security is a different story. http://fairmark.com/capgain/wash/wsoption.htm
Personally I use two funds following different indices to TLH especially if one of the trades is in tax advantaged. It's one thing to have your tax loss postponed but the total loss of the tax loss is another matter.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.
- Earl Lemongrab
- Posts: 7270
- Joined: Tue Jun 10, 2014 1:14 am
Re: ETF - open secret - cap gains tax loophole
There is certainly no hard evidence that two ETFs (or mutual funds, this isn't unique to the product) that follow the same index are substantially identical. The IRS just has not bothered to provide any guidance in this area, other than to say that "all factors must be taken into account" or words to that effect.
There used to a IRS publication, now apparently obsolete, that specifically said that mutual funds from different providers would generally NOT be substantially identical. Was the pub made obsolete to negate that, or for other reasons? I don't know. If not, is the idea still correct to the IRS? Again, I don't know.
The IRS seems to want the easy way, look for actual same CUSIP and implement covered shares.
There used to a IRS publication, now apparently obsolete, that specifically said that mutual funds from different providers would generally NOT be substantially identical. Was the pub made obsolete to negate that, or for other reasons? I don't know. If not, is the idea still correct to the IRS? Again, I don't know.
The IRS seems to want the easy way, look for actual same CUSIP and implement covered shares.
Re: ETF - open secret - cap gains tax loophole
I have seen first hand deep discussions on this, with fund accountants and IRS auditors. This would be an issue for them. They would expect you to provide a good chunk of documentation proving that there was not a substantial overlap between the 2. While this was for RICs, this suggests it would apply to individual investors as well. It is just the IRS does not bother with the small fish in cases like this.triceratop wrote:I am aware of the lack of IRS guidance. That does not mean those intentionally violating the intent and spirit of the law are free and clear, because the IRS could choose to begin enforcing this (and end up in tax court eventually, I would venture to guess).Thesaints wrote:The substantially identical determination is actually a grey area and the IRS has not found univocally one way or another. This often comes up with investors writing DITM calls on an ETF slightly different from their holdings.
The rule of thumb is that less than 85% overlap would represent a transaction done for tax purposes, not economic purposes. The IRS has purposefully left the rule vague. They don't want to invite rules lawyers to find loopholes.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Re: ETF - open secret - cap gains tax loophole
Excerpts from http://fairmark.com/capgain/wash/wsident.htm on substantially identical:alex_686 wrote:I have seen first hand deep discussions on this, with fund accountants and IRS auditors. This would be an issue for them. They would expect you to provide a good chunk of documentation proving that there was not a substantial overlap between the 2. While this was for RICs, this suggests it would apply to individual investors as well. It is just the IRS does not bother with the small fish in cases like this.
The rule of thumb is that less than 85% overlap would represent a transaction done for tax purposes, not economic purposes. The IRS has purposefully left the rule vague. They don't want to invite rules lawyers to find loopholes.
There's some debate, but no direct authority, on the question of whether two mutual funds keying off the same index are substantially identical for purposes of the wash sale rule.
...
My feeling is that those differences aren't enough to prevent the two funds from being substantially identical.
A managed fund should not be considered substantially identical to an index fund (although even here the IRS could disagree).
The problem with this article is that it from 2007.The bottom line is that risk and the wash sale rule are tied together. If you have a strategy that completely eliminates risk from your sale and repurchase, it's likely that you have a wash sale.
The 85% rule of thumb seems to me like Alex has a very big thumb.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.
- Earl Lemongrab
- Posts: 7270
- Joined: Tue Jun 10, 2014 1:14 am
Re: ETF - open secret - cap gains tax loophole
The spirit and intent of the law isn't all that clear, and is interpreted differently by various people. Some claim that if you have the same market exposure, then the funds are substantially identical, and talk about overlaying charts. I suspect they wouldn't be very satisfied with the exchange of VOO for VV.
You can see how those compare (or their MF versions anyway, easier to do at Morningstar):
In this chart right here.
You can see how those compare (or their MF versions anyway, easier to do at Morningstar):
In this chart right here.
- triceratop
- Posts: 5838
- Joined: Tue Aug 04, 2015 8:20 pm
- Location: la la land
Re: ETF - open secret - cap gains tax loophole
One could make the case that with a large cap index fund you receive exposure to more than 20% more stocks (612 vs. 505). I tend to think exchanging for another fund following the same index is a wash sale, but even I don't think VOO and VV are substantially identical. Also, VOO has substantially different index inclusion critera (and different index companies) which is a valid economic reason to switch IMO.Earl Lemongrab wrote:The spirit and intent of the law isn't all that clear, and is interpreted differently by various people. Some claim that if you have the same market exposure, then the funds are substantially identical, and talk about overlaying charts. I suspect they wouldn't be very satisfied with the exchange of VOO for VV.
You can see how those compare (or their MF versions anyway, easier to do at Morningstar):
In this chart right here.
Note: not legal or tax advice, obviously.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."
Re: ETF - open secret - cap gains tax loophole
If one replaces SPY with IVE half the portfolio has been exchanged with identical securities.
It is up to the IRS auditor to try to enforce the relative wash sale. IMO, they would have very good chance of prevailing, should the taxpayer decide to fight it.
On the other hand, two funds tracking the same index, but with different techniques would be a long shot.
It is up to the IRS auditor to try to enforce the relative wash sale. IMO, they would have very good chance of prevailing, should the taxpayer decide to fight it.
On the other hand, two funds tracking the same index, but with different techniques would be a long shot.
- triceratop
- Posts: 5838
- Joined: Tue Aug 04, 2015 8:20 pm
- Location: la la land
Re: ETF - open secret - cap gains tax loophole
"relative wash sale"? The IRS doesn't enforce wash sale rules proportionally to the extent securities are substantially identical. It either is, or isn't (problem is we do not know). Where did you get the idea that that was how the wash sale rule was enforced? An S&P500 Value fund has far different economic exposures than a S&P500 fund.Thesaints wrote:If one replaces SPY with IVE half the portfolio has been exchanged with identical securities.
It is up to the IRS auditor to try to enforce the relative wash sale. IMO, they would have very good chance of prevailing, should the taxpayer decide to fight it.
On the other hand, two funds tracking the same index, but with different techniques would be a long shot.
Do you have any reason why they would have a very good chance of prevailing? Sounds like a longshot for them.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."
- Earl Lemongrab
- Posts: 7270
- Joined: Tue Jun 10, 2014 1:14 am
Re: ETF - open secret - cap gains tax loophole
One can make a case for a number of things. There is no clear-cut answer. You've decided those criteria are the correct ones versus market position. You could make an argument that with mutual funds the behavior is more important than the precise makeup. It's not one that I would make, but it isn't obviously wrong. That's mainly because there just aren't a lot of rules.triceratop wrote:One could make the case that with a large cap index fund you receive exposure to more than 20% more stocks (612 vs. 505). I tend to think exchanging for another fund following the same index is a wash sale, but even I don't think VOO and VV are substantially identical. Also, VOO has substantially different index inclusion critera (and different index companies) which is a valid economic reason to switch IMO.
I would be happy, should the occasion arise, to swap IVV for VOO. I promise to do if I ever get a loss and it's in an account where I can do it with no commission. After all, the consequences if it were flagged would be minimal and we'd have an actual data point.
Re: ETF - open secret - cap gains tax loophole
Ok, so I can exchange my SPY for IVV + IVW ? Except for a slightly different expense ratio the two positions are identical. Do you think an IRS auditor would have some ground here ?triceratop wrote:"relative wash sale"? The IRS doesn't enforce wash sale rules proportionally to the extent securities are substantially identical. It either is, or isn't (problem is we do not know). Where did you get the idea that that was how the wash sale rule was enforced? An S&P500 Value fund has far different economic exposures than a S&P500 fund.Thesaints wrote:If one replaces SPY with IVE half the portfolio has been exchanged with identical securities.
It is up to the IRS auditor to try to enforce the relative wash sale. IMO, they would have very good chance of prevailing, should the taxpayer decide to fight it.
On the other hand, two funds tracking the same index, but with different techniques would be a long shot.
Do you have any reason why they would have a very good chance of prevailing? Sounds like a longshot for them.
As for the SPY to IVV exchange is concerned, the argument is that each ETF share IS a basket of a variety of shares and the two baskets in questions contain the very same shares for half of their value.
Certainly, if I exchange $100 worth of AAPL for $50 of AAPL + $50 of MSFT there is a potential wash sale covering half of my capital. No one would ever dispute that.
Analogous argument for funds, rather than ETF is a little more arduous. ETF's ARE the shares they are made of, funds not necessarily: they have different managers, for one, and their portfolios are not perfectly known at any time.
Re: ETF - open secret - cap gains tax loophole
If the IRS was going to claim that an S&P 500 was substantially identical to a Russell 1000 we would know about it already. Is a Ford and a Chevy substantially identical if they are both trucks? Not.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.
Re: ETF - open secret - cap gains tax loophole
Ford and Chevy certainly not.Doc wrote:If the IRS was going to claim that an S&P 500 was substantially identical to a Russell 1000 we would know about it already. Is a Ford and a Chevy substantially identical if they are both trucks? Not.
S&P 500 and Russell 1000, they certainly have a case if held in ETF form. Besides, they already enforce the wash sale rule when creation units are involved.
Re: ETF - open secret - cap gains tax loophole
I assume that by "they" you mean the IRS.Thesaints wrote:S&P 500 and Russell 1000, they certainly have a case if held in ETF form.
http://finance.zacks.com/substantially- ... -5850.htmlUnlike many other types of securities, the IRS has not given clear guidelines about what would be viewed as substantially identical if a mutual fund is sold and another mutual fund is purchased within the wash sale window.
However, at least with mutual funds, the funds could and often were managed in a substantively different manner. While large diversified mutual funds often have a big chunk of overlap, there are clearly at least some differences in the underlying stocks, as well as the manner by which the manager buys and sells those stocks over time. Given these differences, and what at least was usually just “limited” overlap, mutual funds have kept their “ordinarily not substantially identical” treatment.
With ETFs, though, the situation gets much murkier, as nominally different ETF funds and even ETF providers may in the end be mimicking the exact same underlying index and basket of stocks.
https://www.kitces.com/blog/the-wash-sa ... -and-etfs/
My interpretation is that an S&P 500 ETF is not substantially identical to a Russell 1000 ETF. But broker A's 500 ETF and broker B's 500 ETF is something else but I can find no IRS ruling on that comparison. I think if there was a ruling we would all know about it.
The IRS reporting rules for brokers are same cusip and same account so I wouldn't worry about using two funds or ETF's following the same index from different fund providers while making my buy/sell in different accounts. Nevertheless I don't use pairs with identical indices JIC.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.
Re: ETF - open secret - cap gains tax loophole
No doubt that a creation unit for a S&P 500 and a Russel 1000 ETF's coincide for around 80%.
No doubt that if someone were using switching between said creation units to harvest losses violating the WSR the IRS would be all over him.
No doubt that if the above is true for creation units it is necessarily true for ETF shares, which are nothing else than a submultiple.
The doubt is if the IRS feels pursuing such practice to be worth their time and effort.
And that is essentially what the article in the OP says.
No doubt that if someone were using switching between said creation units to harvest losses violating the WSR the IRS would be all over him.
No doubt that if the above is true for creation units it is necessarily true for ETF shares, which are nothing else than a submultiple.
The doubt is if the IRS feels pursuing such practice to be worth their time and effort.
And that is essentially what the article in the OP says.
Re: ETF - open secret - cap gains tax loophole
I think about all one say is that substantially identical is somewhat less than identical. Whether it is 51% or 99% of the same stocks in the same proportion, no one knows.
- Earl Lemongrab
- Posts: 7270
- Joined: Tue Jun 10, 2014 1:14 am
Re: ETF - open secret - cap gains tax loophole
SPY and IVV are both S&P 500 ETFs. I think you meant IVE, so you have a combination of the growth and value 500s. I certainly don't think any combination of purchased securities would be considered a wash.Thesaints wrote:Ok, so I can exchange my SPY for IVV + IVW ? Except for a slightly different expense ratio the two positions are identical. Do you think an IRS auditor would have some ground here ?
Then again, I think it highly unlikely one would get an audit for SPY->IVV. If I did, I would respond with a large list of "differences" that don't make them substantially identical. In that particular case, I'd start with the fact that SPY is a Unit Investment Trust.
- Earl Lemongrab
- Posts: 7270
- Joined: Tue Jun 10, 2014 1:14 am
Re: ETF - open secret - cap gains tax loophole
I have a lot of doubts about your "no doubts". Creation units involve the purchase or sale of individual securities that make up the fund. That's WAY different than buying and selling the finished product.Thesaints wrote:No doubt that a creation unit for a S&P 500 and a Russel 1000 ETF's coincide for around 80%.
No doubt that if someone were using switching between said creation units to harvest losses violating the WSR the IRS would be all over him.
No doubt that if the above is true for creation units it is necessarily true for ETF shares, which are nothing else than a submultiple.
- nisiprius
- Advisory Board
- Posts: 52107
- Joined: Thu Jul 26, 2007 9:33 am
- Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry
Re: ETF - open secret - cap gains tax loophole
To swap S&P 500 for the S&P 500 seems like deliberately thumbing one's nose at the IRS. They probably don't care, and if they ever do care they will probably give warning and set clear rules--but why do it? it's pretty hard for me to believe that anyone seriously thinks the S&P 500 is so superior to other large-cap indexes that it is an accept-no-substitutes situation. In fact, while I personally think it's poppycock in the sense of being enough to matter, the conventional wisdom is that the S&P 500 has a number of small, nit-picking flaws.
Seriously... in your heart, don't you think that the Vanguard 500 ETF, VOO, and SPDR S&P 500 ETF, SPY, are, let's say this with a straight face, substantially more "substantially identical" than VOO and the Vanguard Large-Cap ETF, VV?
Seriously... in your heart, don't you think that the Vanguard 500 ETF, VOO, and SPDR S&P 500 ETF, SPY, are, let's say this with a straight face, substantially more "substantially identical" than VOO and the Vanguard Large-Cap ETF, VV?
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
Re: ETF - open secret - cap gains tax loophole
That's not correct. Creation units involve the exchange of basket of securities for ETF shares (or vicecersa). There is no purchase, nor sale involved and that's precisely what makes ETF's more tax efficient than ordinary funds.Earl Lemongrab wrote: I have a lot of doubts about your "no doubts". Creation units involve the purchase or sale of individual securities that make up the fund. That's WAY different than buying and selling the finished product.
- Earl Lemongrab
- Posts: 7270
- Joined: Tue Jun 10, 2014 1:14 am
Re: ETF - open secret - cap gains tax loophole
Please present your evidence on the matter.Thesaints wrote:That's not correct. Creation units involve the exchange of basket of securities for ETF shares (or vicecersa). There is no purchase, nor sale involved and that's precisely what makes ETF's more tax efficient than ordinary funds.Earl Lemongrab wrote: I have a lot of doubts about your "no doubts". Creation units involve the purchase or sale of individual securities that make up the fund. That's WAY different than buying and selling the finished product.
Re: ETF - open secret - cap gains tax loophole
Read the prospectus of any ETF.
- Earl Lemongrab
- Posts: 7270
- Joined: Tue Jun 10, 2014 1:14 am
Re: ETF - open secret - cap gains tax loophole
That will provide evidence that the IRS is declaring wash sales between S&P 500 and R1000 ETFs? I don't think so. I will assume you have no evidence.
Re: ETF - open secret - cap gains tax loophole
There are two sides to the ETF transactionThesaints wrote:That's not correct. Creation units involve the exchange of basket of securities for ETF shares (or vicecersa). There is no purchase, nor sale involved and that's precisely what makes ETF's more tax efficient than ordinary funds.Earl Lemongrab wrote: I have a lot of doubts about your "no doubts". Creation units involve the purchase or sale of individual securities that make up the fund. That's WAY different than buying and selling the finished product.
1) The fund company where the wash sale issue is apparently (possibly) non-existent.
2) The authorized participant side where the trade is not only substantially but in essence exactly identical.
The latter case is not different from option scenario where there I believe IRS rulings. But they are large financial institutions that are worth the IRS going after if they are breaking the rules. So they either don't give a hoot about wash sales, they just wait the 30 days somehow or the rules doesn't apply.
We don't know but I would put "don't give a hoot" high on the list.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.
Re: ETF - open secret - cap gains tax loophole
From the SEC:Earl Lemongrab wrote:Please present your evidence on the matter.Thesaints wrote:That's not correct. Creation units involve the exchange of basket of securities for ETF shares (or vicecersa). There is no purchase, nor sale involved and that's precisely what makes ETF's more tax efficient than ordinary funds.Earl Lemongrab wrote: I have a lot of doubts about your "no doubts". Creation units involve the purchase or sale of individual securities that make up the fund. That's WAY different than buying and selling the finished product.
https://www.sec.gov/investor/alerts/etfs.pdf
Now, a point. The IRS is very good at telling you what is illegal. The IRS is very good at telling you what records to keep. They don't tell you what is legal. This SEC document is very good. They lead you right up to the edge and then back off, saying they don't offer tax advice. It is the nature of the beast.
This is a good example. When I worked with a investment management company, they asked us to keep records so we could justify that there was not a substantial overlap.Earl Lemongrab wrote:The spirit and intent of the law isn't all that clear, and is interpreted differently by various people. Some claim that if you have the same market exposure, then the funds are substantially identical, and talk about overlaying charts. I suspect they wouldn't be very satisfied with the exchange of VOO for VV.
They did not care about economic exposure. If you overlaid 2 different charts and got similar results that did not matter.
They asked us to generate and retain reports showing the overlap at the weighted holdings level. They wanted to know what the overlap was. VOO and VV would have a high overlap so that probably would count as substantial overlap. The number that we came up with was 85% - if the overlap was greater than 85% than it was substantially similar. Other people I have worked with in the industry also uses that number. We can look at the court cases that IRS has brought and the opinions that they have issued.
Here is the problem that I think you are facing. The IRS has given the method that they want you to use for a substantial overlap test. The problem is that they have never formally issued a ruling. Is it 90%? 80%? We have letters which suggest what IRS opinion is but that is pretty weak tea. Then again, the IRS almost never issues a formal statement on any issue. You have got to go with the common law approach.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Re: ETF - open secret - cap gains tax loophole
They just pay the taxes. Part of doing business. Note, the financial institution's taxes fall under trading profit rules. It is just treated as ordinary business income. It does not fall under the capital gains rule.Doc wrote:The latter case is not different from option scenario where there I believe IRS rulings. But they are large financial institutions that are worth the IRS going after if they are breaking the rules. So they either don't give a hoot about wash sales, they just wait the 30 days somehow or the rules doesn't apply.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Re: ETF - open secret - cap gains tax loophole
The ETF issuer doesn't do any sales; they do redemptions in kind which are not taxable. No WSR to be worried about in their case.Doc wrote:There are two sides to the ETF transactionThesaints wrote:That's not correct. Creation units involve the exchange of basket of securities for ETF shares (or vicecersa). There is no purchase, nor sale involved and that's precisely what makes ETF's more tax efficient than ordinary funds.Earl Lemongrab wrote: I have a lot of doubts about your "no doubts". Creation units involve the purchase or sale of individual securities that make up the fund. That's WAY different than buying and selling the finished product.
1) The fund company where the wash sale issue is apparently (possibly) non-existent.
2) The authorized participant side where the trade is not only substantially but in essence exactly identical.
The latter case is not different from option scenario where there I believe IRS rulings. But they are large financial institutions that are worth the IRS going after if they are breaking the rules. So they either don't give a hoot about wash sales, they just wait the 30 days somehow or the rules doesn't apply.
We don't know but I would put "don't give a hoot" high on the list.
If instead a large institution wanted to harvest losses doing the following:
- sell stocks and book a capital loss
- at the same time, purchase ETF shares with a basket containing the security sold (but not only!).
- redeem shares for underlying securities
you bet the IRS would go after them, limited to the overlap of securities.
How this is substantially different from selling SPY and purchasing IVV, other than in the quantities involved, you tell me.
SPY is not substantially identical to IVV, but 50% of the underlying securities are. The IRS would have an easy case, if they wanted to go after individual investors.