Tax lots and TLH question

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JaySayms
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Tax lots and TLH question

Post by JaySayms » Thu Aug 27, 2015 10:54 am

Let's say all you own is a total stock market fund, let's call it fund A. Let's say you make quarterly contributions into fund A. That means for any given year you have 4 tax lots or tax "buckets" for this fund. Each tax lot or bucket has a different cost basis or share price which is determined by how much the shares are selling for at the time of purchase.

Now let's say in the 4th quarter of the year the fund suffers a 20% loss and you decide to TLH the fund. All other tax lots since you have been buying the fund have gains, no losses. Because you chose spec ID as your cost basis, you now can specify that you only want to replace your 4th quarter tax lot shares with fund that is not substantially equivalent (thereby selling the losing shares and retaining your position in the market).
You now own both fund A (you retained the first three tax lot quarters of the year) and a smaller portion of fund B.

Questions:

- most people on here are talking about exchanging an entire fund, not specific tax lots. If you are doing it this way, what is the benefit of using spec ID for your cost basis? It seems that the Vanguard default of average cost would be sufficient.

- If you are selling certain tax lots and keeping others, am I right to assume that you now own both the original fund (Fund A) and the alternate fund (Fund B)? If you are doing this, does the complexity of your portfolio management go up, certainly in terms of TLH?

- Spec ID, I believe, is useful for those who understand the nuances of tax code and use it for much, much more than TLH. They could be used if you for example needed to sell a portion of Fund A and wanted to minimize your tax consequences by selling with the most advantageous combination of short and long term gains. True?

- Finally, getting away from selling specific tax lots for the purposes of TLH means that you do not need to worry about when you last purchased Fund A, correct? If you sell the entire fund, the 31 day rule only applies to the amount of time before you can buy back into Fund A, regardless of whether you purchased the fund the day before the TLH event.

- Lastly, are they saying "Boo" or "Boo-urns"???
Last edited by JaySayms on Thu Aug 27, 2015 12:08 pm, edited 1 time in total.

Roothy
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Re: Tax lots and TLH question

Post by Roothy » Thu Aug 27, 2015 11:01 am

I would like to know the answer to all of these questions, too, except for the last one. ;) So I'm posting this to bump the post.

ved
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Re: Tax lots and TLH question

Post by ved » Thu Aug 27, 2015 11:14 am

I'll take a shot at this.
JaySayms wrote:Step 2.1:

- most people on here are talking about exchanging an entire fund, not specific tax lots. If you are doing it this way, what is the benefit of using spec ID for your cost basis? It seems that the Vanguard default of average cost would be sufficient.
If you are selling all the shares in the fund - average basis is sufficient. Watch out for any dividend re-investment (that you have not turned off in this account and elsewhere) that may buy new shares
JaySayms wrote: - If you are selling certain tax lots and keeping others, am I right to assume that you now own both the original fund (Fund A) and the alternate fund (Fund B)? If you are doing this, does the complexity of your portfolio management go up, certainly in terms of TLH?
Yes. You own both funds. You could get lucky if Fund B loses in value after 30 days of the 1st TLH and you could TLH Fund B back into Fund A. However, this may not happen. So, be comfortable with owning both funds for a long time.
JaySayms wrote: - Spec ID, I believe, is useful for those who understand the nuances of tax code and use it for much, much more than TLH. They could be used if you for example needed to sell a portion of Fund A and wanted to minimize your tax consequences by selling with the most advantageous combination of short and long term gains. True?
I don't know. I just converted to SpecID for the express purpose of TLHing.
JaySayms wrote: - Finally, getting away from selling specific tax lots for the purposes of TLH means that you do not need to worry about when you last purchased Fund A, correct? If you sell the entire fund, the 31 day rule only applies to the amount of time before you can buy back into Fund A, regardless of whether you purchased the fund the day before the TLH event.
Correct.

Topic Author
JaySayms
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Re: Tax lots and TLH question

Post by JaySayms » Thu Aug 27, 2015 12:08 pm

ved wrote:I'll take a shot at this.
JaySayms wrote:Step 2.1:

- most people on here are talking about exchanging an entire fund, not specific tax lots. If you are doing it this way, what is the benefit of using spec ID for your cost basis? It seems that the Vanguard default of average cost would be sufficient.
If you are selling all the shares in the fund - average basis is sufficient. Watch out for any dividend re-investment (that you have not turned off in this account and elsewhere) that may buy new shares
JaySayms wrote: - If you are selling certain tax lots and keeping others, am I right to assume that you now own both the original fund (Fund A) and the alternate fund (Fund B)? If you are doing this, does the complexity of your portfolio management go up, certainly in terms of TLH?
Yes. You own both funds. You could get lucky if Fund B loses in value after 30 days of the 1st TLH and you could TLH Fund B back into Fund A. However, this may not happen. So, be comfortable with owning both funds for a long time.
JaySayms wrote: - Spec ID, I believe, is useful for those who understand the nuances of tax code and use it for much, much more than TLH. They could be used if you for example needed to sell a portion of Fund A and wanted to minimize your tax consequences by selling with the most advantageous combination of short and long term gains. True?
I don't know. I just converted to SpecID for the express purpose of TLHing.

JaySayms wrote: - Finally, getting away from selling specific tax lots for the purposes of TLH means that you do not need to worry about when you last purchased Fund A, correct? If you sell the entire fund, the 31 day rule only applies to the amount of time before you can buy back into Fund A, regardless of whether you purchased the fund the day before the TLH event.
Correct.

Awesome, thanks Ved. Since you converted to specID, I assume you are NOT one of the folks exchanging entire funds, but instead pick and choose your tax lots and are comfortable holding multiple overlapping funds for as long as you need to. If you own both funds however, and they are highly correlated and thus at the next correction both suffer losses (hypothetically), how do you TLH? Do you simply TLH Fund B back into Fund A (or vise versa) and leave the other one alone?

ved
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Re: Tax lots and TLH question

Post by ved » Thu Aug 27, 2015 12:37 pm

You could do Fund A to Fund B (or vice-versa) if you are willing to forgo the TLH opportunity of one of the funds.
Or, you could bring Fund C into the picture :D

Topic Author
JaySayms
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Re: Tax lots and TLH question

Post by JaySayms » Thu Aug 27, 2015 1:08 pm

ved wrote:You could do Fund A to Fund B (or vice-versa) if you are willing to forgo the TLH opportunity of one of the funds.
Or, you could bring Fund C into the picture :D

My head just exploded..... :oops:

Dan17
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Re: Tax lots and TLH question

Post by Dan17 » Thu Aug 27, 2015 1:26 pm

Thanks for asking some of the questions I've been wondering myself. I wasn't able to find any of this through the forum search (so many TLH threads to go through lol).

A few additional things I've been unsure of:
1. Now that you have a Fund A and Fund B with essentially the same purpose in your portfolio, which fund would you then contribute to quarterly (continuing from OP's example)? Does it matter if it is Fund A or Fund B now?

2. Let's say in the future, you have tax lots in both Fund A and Fund B that you would like to TLH. Is there any way to TLH both? I assume you would need a Fund C at this point, but I can imagine this getting complicated if you keep on adding more and more funds with the same purpose to your portfolio.

livesoft
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Re: Tax lots and TLH question

Post by livesoft » Thu Aug 27, 2015 1:27 pm

JaySayms wrote:- most people on here are talking about exchanging an entire fund, not specific tax lots. If you are doing it this way, what is the benefit of using spec ID for your cost basis? It seems that the Vanguard default of average cost would be sufficient.
Most people on here talking are novices and not thinking through things clearly. They also seem to be afraid of math and tax lots. It is also possible that they are new to investing in taxable accounts and do not have major positions purchased say in April 2009 which would make average basis ridiculous.


- If you are selling certain tax lots and keeping others, am I right to assume that you now own both the original fund (Fund A) and the alternate fund (Fund B)? If you are doing this, does the complexity of your portfolio management go up, certainly in terms of TLH?
Yes, I own VTI, VTSAX (oops not anymore), VLCAX, and VFIAX, but my portfolio is actually not complex from the funds I own, but because of the 15+ separate accounts that I am forced to have. If you can't deal with it, then perhaps you cannot even use a grocery store which is way more complex.

- Spec ID, I believe, is useful for those who understand the nuances of tax code and use it for much, much more than TLH. They could be used if you for example needed to sell a portion of Fund A and wanted to minimize your tax consequences by selling with the most advantageous combination of short and long term gains. True?
I do not share your belief. Spec ID is natural and the only way to keep track of things. Shares will ALWAYS have the SAME cost basis from the day you bought them. They will never change (if you avoid wash sales). This is quite the contrast from average basis. With average basis, the basis of any share changes because of the buying and selling of subsequent shares. That does not happen with Spec ID.

I think average basis was created by the financial industry so that they could pull the wool over the eyes of clients in at least two ways:
1. Make it seem more complicated than it is (average basis is more complicated than Spec ID.
2. Make losses disappear under the mantle of average basis: "Oh look! You've made money!" (when you really haven't).


- Finally, getting away from selling specific tax lots for the purposes of TLH means that you do not need to worry about when you last purchased Fund A, correct? If you sell the entire fund, the 31 day rule only applies to the amount of time before you can buy back into Fund A, regardless of whether you purchased the fund the day before the TLH event.
If you get trapped into selling all your shares all the time, then you are wasting the benefits of tax-loss harvesting.

Just stop being fooled by all the posts here. Use Spec ID for all your funds and do it all the time.
Quiz time: What did you pay for your last car? What is the average basis for all the cars you have bought in your lifetime?
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Roothy
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Re: Tax lots and TLH question

Post by Roothy » Thu Aug 27, 2015 1:55 pm

livesoft wrote:
Just stop being fooled by all the posts here. Use Spec ID for all your funds and do it all the time.[/color]
Just a quick point: if you switch right now to "specific id," Vanguard at least doesn't "backdate" your basis to whatever you actually paid. It just takes each lot and prices it at the average cost. Future share lots, presumably, will be (forever) priced at whatever you paid for them.

In other words, if you ever want the advantage of specific ID, you need to set it that way in advance. I don't know why Vanguard doesn't know what I specifically paid for my share lots--or rather, I know they know, I just don't know why they won't tell me. I guess I could dig through my past statements (how many years are kept online?) and figure it out for myself...

livesoft
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Re: Tax lots and TLH question

Post by livesoft » Thu Aug 27, 2015 1:58 pm

^If one sold shares with average basis as the cost method, then those shares have to remain with the method until they are sold, don't they? So it may not be a Vanguard problem. It may be an IRS mandate.
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House Blend
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Re: Tax lots and TLH question

Post by House Blend » Thu Aug 27, 2015 2:00 pm

JaySayms wrote:- most people on here are talking about exchanging an entire fund, not specific tax lots. If you are doing it this way, what is the benefit of using spec ID for your cost basis? It seems that the Vanguard default of average cost would be sufficient.
Using average basis while trying to TLH is like trying to downhill ski without any change of elevation.

If you really want to use TLH, and I'm not recommending that you should, then you should be prepared to abandon old habits. One of those habits is average basis.

People doing TLH by selling all shares should only be doing it if the result is a net loss. They should also realize that they are going about it in a half-baked fashion (unless they are new-ish to investing and all of the shares they hold have losses.)

In your example, if you sell all shares of your fund, rather than just the lots that have losses, you might very well end up with a net gain. If so, then you've managed to do something double plus ungood. You've increased your tax bill, and worse, you've done it by realizing short term gains--these are taxed at your full marginal rate.
- If you are selling certain tax lots and keeping others, am I right to assume that you now own both the original fund (Fund A) and the alternate fund (Fund B)? If you are doing this, does the complexity of your portfolio management go up, certainly in terms of TLH?
Of course. Incorporating TLH into an investment strategy is more complex and requires more attention to detail than plan vanilla buy-hold-rebalance.
- Spec ID, I believe, is useful for those who understand the nuances of tax code and use it for much, much more than TLH. They could be used if you for example needed to sell a portion of Fund A and wanted to minimize your tax consequences by selling with the most advantageous combination of short and long term gains. True?
Right. The usefulness of Specific ID goes way beyond the fact that it is the optimal way to deploy TLH. It is the best method for everyone who wants to minimize the tax costs when they sell shares and maximize the tax benefits when they donate shares.
- Finally, getting away from selling specific tax lots for the purposes of TLH means that you do not need to worry about when you last purchased Fund A, correct? If you sell the entire fund, the 31 day rule only applies to the amount of time before you can buy back into Fund A, regardless of whether you purchased the fund the day before the TLH event.
Sorry, I'm unable to decipher that question.

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House Blend
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Re: Tax lots and TLH question

Post by House Blend » Thu Aug 27, 2015 2:30 pm

Roothy wrote:
livesoft wrote:
Just stop being fooled by all the posts here. Use Spec ID for all your funds and do it all the time.[/color]
Just a quick point: if you switch right now to "specific id," Vanguard at least doesn't "backdate" your basis to whatever you actually paid. It just takes each lot and prices it at the average cost. Future share lots, presumably, will be (forever) priced at whatever you paid for them.

In other words, if you ever want the advantage of specific ID, you need to set it that way in advance. I don't know why Vanguard doesn't know what I specifically paid for my share lots--or rather, I know they know, I just don't know why they won't tell me. I guess I could dig through my past statements (how many years are kept online?) and figure it out for myself...
Not correct. Two things are at play here.

1. Let's say you selected average basis for Fund X. Let's assume all shares are covered.
Let's say you sold some shares of Fund X on May 1, 2015 (to pick a random date).
Then all shares of Fund X that you purchased up to that point are forced to use average basis. This is tax law, not Vanguard. You are free to switch to Specific ID for Fund X at any time. Let's say you do this on July 1. This will apply whenever you choose to sell shares purchased after May 1. The older shares are still going to be averaged amongst themselves.

In particular, if you started with average basis, and have never sold shares of Fund X, then when you switch to Specific ID, all of your old shares will also be tracked using Specific ID.

2. Vanguard is slow to convert from one cost basis method to another. If you switched to Spec ID recently, and your lots show that they all have the same cost per share, then either you are in the situation described in Item #1, or Vanguard has not finished the job. In the latter case, you should call Vanguard, and expect that it may take a while for them to fix it.

Edit for clarification: Your use of the phrase "how many years are kept online?" suggests maybe you also own non-covered shares. That's a hand grenade of an entirely different color. For those shares, you can use average basis and let VG track them for you (and once you sell any of those shares using average basis you are stuck with that). Or, you can keep track of cost basis for those shares yourself, and receive minimal cooperation from VG in that endeavor.
Last edited by House Blend on Thu Aug 27, 2015 3:05 pm, edited 1 time in total.

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Re: Tax lots and TLH question

Post by jhfenton » Thu Aug 27, 2015 2:38 pm

In this day and age, I'm amazed at the idea that anyone would ever choose average cost. I don't see a downside to specific identification. The broker does all of the heavy lifting. At TD Ameritrade, I don't even have to pick lots. I just have my default "Tax Lot ID Method" set to "Tax efficient loss harvester." I assume other brokers have a similar automated process.

"Tax efficient loss harvester" translates to the following:
For long positions, the order in which this method sells the tax lots is as follows:

Short-term loss - descending order by cost per share (highest to lowest), and as a result, taking the biggest short-term losses first
Long-term loss - descending order by cost per share
Long-term gain - descending order by cost per share (highest to lowest), and as a result, taking the smallest long-term gain first
Short-term gain - descending order by cost per share

livesoft
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Re: Tax lots and TLH question

Post by livesoft » Thu Aug 27, 2015 3:07 pm

^Nice text quoted to go with the algorithm. One can do that in their head, too, but it is great to see it written down.
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Dan17
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Re: Tax lots and TLH question

Post by Dan17 » Thu Aug 27, 2015 3:31 pm

Can someone answer my 2 simple questions that got skipped over please? I would greatly appreciate it :D
Dan17 wrote:Thanks for asking some of the questions I've been wondering myself. I wasn't able to find any of this through the forum search (so many TLH threads to go through lol).

A few additional things I've been unsure of:
1. Now that you have a Fund A and Fund B with essentially the same purpose in your portfolio, which fund would you then contribute to quarterly (continuing from OP's example)? Does it matter if it is Fund A or Fund B now?

2. Let's say in the future, you have tax lots in both Fund A and Fund B that you would like to TLH. Is there any way to TLH both? I assume you would need a Fund C at this point, but I can imagine this getting complicated if you keep on adding more and more funds with the same purpose to your portfolio.

livesoft
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Re: Tax lots and TLH question

Post by livesoft » Thu Aug 27, 2015 3:39 pm

Dan17 wrote:Thanks for asking some of the questions I've been wondering myself. I wasn't able to find any of this through the forum search (so many TLH threads to go through lol).

A few additional things I've been unsure of:
1. Now that you have a Fund A and Fund B with essentially the same purpose in your portfolio, which fund would you then contribute to quarterly (continuing from OP's example)? Does it matter if it is Fund A or Fund B now?
When I own shares of both funds, then I contribute to the so-called "better" fund if that would not create a wash sale. What is "better"?Well, it is whatever made you choose the fund over the other one in the first place. It could be expense ratio or maybe the better fund has small-caps or maybe the better fund has a value tilt. You should know in your own mind which fund is the better fund. And when rebalancing out of the asset class, I will certainly consider using the non-better fund to do so. If this doesn't seem like common-sense to you, let me know.

2. Let's say in the future, you have tax lots in both Fund A and Fund B that you would like to TLH. Is there any way to TLH both? I assume you would need a Fund C at this point, but I can imagine this getting complicated if you keep on adding more and more funds with the same purpose to your portfolio.
There are plenty of ways to TLH both. Rather than point them out, let me ask you to use your imagination and think about how you would do it, then I can comment on your suggestions.
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Dan17
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Re: Tax lots and TLH question

Post by Dan17 » Thu Aug 27, 2015 3:50 pm

livesoft wrote:
Dan17 wrote:Thanks for asking some of the questions I've been wondering myself. I wasn't able to find any of this through the forum search (so many TLH threads to go through lol).

A few additional things I've been unsure of:
1. Now that you have a Fund A and Fund B with essentially the same purpose in your portfolio, which fund would you then contribute to quarterly (continuing from OP's example)? Does it matter if it is Fund A or Fund B now?
When I own shares of both funds, then I contribute to the so-called "better" fund if that would not create a wash sale. What is "better"?Well, it is whatever made you choose the fund over the other one in the first place. It could be expense ratio or maybe the better fund has small-caps or maybe the better fund has a value tilt. You should know in your own mind which fund is the better fund. And when rebalancing out of the asset class, I will certainly consider using the non-better fund to do so.

2. Let's say in the future, you have tax lots in both Fund A and Fund B that you would like to TLH. Is there any way to TLH both? I assume you would need a Fund C at this point, but I can imagine this getting complicated if you keep on adding more and more funds with the same purpose to your portfolio.
There are plenty of ways to TLH both. Rather than point them out, let me ask you to use your imagination and think about how you would do it, then I can comment on your suggestions.
1. Thanks! I just wanted to make sure. That was my original suspicion, but I wasn't sure if there was a strategy that I was missing that could be beneficial.

2. From what I read, the two solutions that come to mind would be:
a) Sell losses from both funds, sit in cash for 31 days, and buy back into the "better" fund after that (though I don't really like the idea of sitting out for 31 days)
b) Exchange the two funds into a third fund that is similar. I imagine this is what you do based on your other post where you stated you have multiple holdings (both mutual funds and ETFs) that are similar to the TSM. I just kept thinking this method could potentially get more and more complicated and you could end up with 7 similar funds that all do the same thing or something. There isn't really a problem with that for me, but it seemed to go against the Boglehead philosophy of keeping everything simple.

Is there another viable strategy?

Also, I would reply under your blue text, but I don't know how. Sorry!

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Re: Tax lots and TLH question

Post by livesoft » Thu Aug 27, 2015 3:57 pm

Here are some other ideas:

Say one has a loss in Fund A and in Fund B, one could buy the amount of shares with loss in either fund with money from selling a bond fund. One would be doubled-up for a little while, then when the 31 days was up, sell the shares that have a loss.

Or since one knows that asset classes are correlated, if one is tax-loss harvesting an international fund, just sell it and buy more share of one's US fund. Or vice versa. Or if one is tax-loss harvesting a small-cap fund, then just more shares of one's total market fund. These temporary excursions from some asset allocation ideal that one has are usually well within any rebalancing bands that one has anyways.

Since I try to start EVERY year with no losing positions because I have tax-loss harvested all the losing positions by the end of December, that means that any lots with losing positions during the year will not be large and will be well-within any reblancing bands that I have set. That means that doubling-up or even going to another asset class (except cash) will probably not make a big difference in the grand scheme of things.
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Dan17
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Re: Tax lots and TLH question

Post by Dan17 » Fri Aug 28, 2015 7:15 am

Okay, I understand what you're suggesting. That makes a lot of sense, and I'll probably do that in the future. I'm a new investor, so my taxable accounts are still pretty small right now.. can't do those suggested strategies yet without forcing my AA to go out of my rebalancing bands. I'm thinking I could actually compensate in my 401k funds if necessary (exchange funds in the opposite direction of TLH) because they don't charge me any fees to rebalance, and my 401k funds wouldn't be considered substantially identical to my taxable funds (but I'm going to do some more research on this topic just to make sure). Does this sound like a viable strategy too? I would probably only do this if my portfolio ever gets too complicated for my liking, and I don't want to add a Fund E or something.

Thank you so much for taking the time to respond.

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Re: Tax lots and TLH question

Post by livesoft » Fri Aug 28, 2015 7:24 am

Yes, one should use all the tools and accounts available to them.

And that reminds me: Vanguard does not enforce its frequent transaction policy across accounts. For instance, sell in taxable restricts (but does not prevent!) from buying the same fund for a while, but one can buy the same fund the next day (or even the same day) in their IRA at Vanguard. And vice versa. And that goes for a spouse's account, too.

Of course, one should avoid wash sales, so one should not usually be looking for ways around the Vanguard restrictions, but maybe one sold for a gain.
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