Substantially Identical?

[ARB57]

I hope to take advantage of the fact that the market is taking a bit of a "breather", and do a little tax loss harvesting. I plan to sell some VTI that I purchased within the last month or so to offset some earlier gains. Two questions: Any recommendations on Funds or ETF's (preferably Vanguard) that will give me somewhat similar equity diversification AT THE SAME TIME not having to worry about buying something that is "substantially identical" (so as to trigger Wash Sale consequences)?

Thanks.

[livesoft]

I would like to request that you edit the thread title and post to change it to "substantially identical" which is the IRS terminology. I want to stamp out the words you used.

VTI can be exchanged with VV or VOO or SPY which are substantially similar but NOT substantially identical and will create no wash sale issues. VV has about 750 stocks while VOO has about 500 stocks. There are others, too, which you should be able to find on your own.

[dbr]

"Substantially identical" is such a wonderfully illogical combination of words. In practice it happens that "identical" applies in real effect and "substantially identical" exists in a never-never land that has never been used by the IRS to tag someone with a mutual fund wash sale.

PS The funds recommended above are fine, of course.

[Phineas J. Whoopee]

Outside of funds, "substantially identical," in practice, means having the same CUSIP number. I think, but can't prove, that congress intended the wording to prevent anybody from successfully avoiding a wash sale by arguing "but your honor, the xyz corp shares I bought weren't literally identical to the shares I sold - I sold ones from a secondary offering and the ones I bought were from the IPO!"

With respect to mutual funds, as noted already in the thread, there never has been a specific rule or ruling, not even a private letter ruling, to guide us. We're in the dark.

The general consensus here at bogleheads.org, which I join, is if a security is simply a different share class of the same fund they clearly are substantially identical; if they follow the very same index they may or may not be (swapping one fund family's S&P 500 fund for another family's, for example, might be an ambiguous case); and if they follow different indices or are actively managed they probably aren't.

Ford and GM clearly aren't substantially identical, despite the fact they both manufacture vehicles. Based on that observation, the conjecture is funds focusing on the same asset class, but using different methods, aren't either. Congress wrote "substantially identical," not "in some ways reminiscent."

Nobody can guarantee any one of us won't be chosen to be the subject of a mutual fund wash sale tax court test case, someday.

Twice, as small parts of much larger tax loss harvesting moves, I had minor wash sales. I complied with the law and reported them as such.

Personally I'd use this site's conventional wisdom and not worry about it. Scratch that. It isn't that I would, it's that I did, and could do so again.

PJW

[Wagnerjb]

Outside of funds, "substantially identical," in practice, means having the same CUSIP number. I think, but can't prove, that congress intended the wording to prevent anybody from successfully avoiding a wash sale by arguing "but your honor, the xyz corp shares I bought weren't literally identical to the shares I sold - I sold ones from a secondary offering and the ones I bought were from the IPO!"

I believe there is a Tax Court ruling that two Treasury bonds that aren't identical are considered "substantially identical". I recall that the maturity dates of the two were not identical, but close to each other. Same for the interest rate. This is a helpful example to understand what the substance of a transaction or investment means.

I believe options (or warrants) have been ruled to be substantially identical to the common stock (in the specific circumstances before the court).

Bottom line is that I don't believe the two instruments necessarily have to have the same CUSIP number.

Best wishes.

[TradingPlaces]

Outside of funds, "substantially identical," in practice, means having the same CUSIP number. I think, but can't prove, that congress intended the wording to prevent anybody from successfully avoiding a wash sale by arguing "but your honor, the xyz corp shares I bought weren't literally identical to the shares I sold - I sold ones from a secondary offering and the ones I bought were from the IPO!"

I believe there is a Tax Court ruling that two Treasury bonds that aren't identical are considered "substantially identical". I recall that the maturity dates of the two were not identical, but close to each other. Same for the interest rate. This is a helpful example to understand what the substance of a transaction or investment means.

I believe options (or warrants) have been ruled to be substantially identical to the common stock (in the specific circumstances before the court).

Bottom line is that I don't believe the two instruments necessarily have to have the same CUSIP number.

Best wishes.

The bit about options being substantially identical to the common stock is laughable. I would argue that a GM call and GM stock are more different than GM Stock and F stock.

Options have additional risks: vega, gamma, skew, etc, and thus should not be considered substantially identical to stock.

[Phineas J. Whoopee]

...
I believe there is a Tax Court ruling that two Treasury bonds that aren't identical are considered "substantially identical". I recall that the maturity dates of the two were not identical, but close to each other. Same for the interest rate. This is a helpful example to understand what the substance of a transaction or investment means.

I believe options (or warrants) have been ruled to be substantially identical to the common stock (in the specific circumstances before the court).

Bottom line is that I don't believe the two instruments necessarily have to have the same CUSIP number.

Best wishes.

Fair enough. I was explicit in my post that literally identical and substantially identical are probably different. Given your post, I'm happy I expressed a level of doubt.

Are you willing provide references to the specific rulings, the one about treasuries being substantially identical despite different maturities (certainly, as bidders know, there are separate auctions, including reopenings, from whose securities with the same maturities have the same CUSIPs), and the other that common stocks are substantially identical to warrants, so we can evaluate them and search for related cases for the purpose of reading the decisions for ourselves?

PJW

[Wagnerjb]

...
I believe there is a Tax Court ruling that two Treasury bonds that aren't identical are considered "substantially identical". I recall that the maturity dates of the two were not identical, but close to each other. Same for the interest rate. This is a helpful example to understand what the substance of a transaction or investment means.

I believe options (or warrants) have been ruled to be substantially identical to the common stock (in the specific circumstances before the court).

Bottom line is that I don't believe the two instruments necessarily have to have the same CUSIP number.

Best wishes.

Fair enough. I was explicit in my post that literally identical and substantially identical are probably different. Given your post, I'm happy I expressed a level of doubt.

Are you willing provide references to the specific rulings, the one about treasuries being substantially identical despite different maturities (certainly, as bidders know, there are separate auctions, including reopenings, from whose securities with the same maturities have the same CUSIPs), and the other that common stocks are substantially identical to warrants, so we can evaluate them and search for related cases for the purpose of reading the decisions for ourselves?

PJW

This paper gives several specific examples.

http://g2ft.com/papers/G2FTAdvancedTopi ... lBonds.pdf

[BolderBoy]

I would bet that selling VG's S&P500 Index fund only to buy another company's S&P500 Index fund inside of 31 days would be considered "substantially identical" if the IRS wanted to pursue it.

[Phineas J. Whoopee]

^^ I see. You have no rulings to cite. From the referenced pdf:

This white paper is a work in progress. We are currently requesting comments on its contents as we complete the final version of this paper. Please send your comments to jmichaels@g2ft.com. We look forward to hearing from you.

g2ft.com appears to be a tax protester site.

I'm all in favor of civil disobedience to right wrongs, but the reference is not to the set of court rulings originally implied.

PJW

[grabiner]

The bit about options being substantially identical to the common stock is laughable. I would argue that a GM call and GM stock are more different than GM Stock and F stock.

Options have additional risks: vega, gamma, skew, etc, and thus should not be considered substantially identical to stock.

Fairmark says that the IRS rule is that a call option is always substantially identical to the stock, according to IRS rules. Selling a deep-in-the-money but is also substantially identical.

It would make more sense for the deep-in-the-money rule to apply both ways. If you sell a stock for $40, and then pay $30 for an option to buy the stock for $10, you haven't really changed your position, as the option is almost certainly going to be exercised (and its $30 price reflects that). If you sell a stock for $40, and then pay $5 for an option to buy the stock for $40, you do have a substantially different position, and the IRS rule doesn't reflect the economic substance.

[Wagnerjb]

^^ I see. You have no rulings to cite. From the referenced pdf:

This white paper is a work in progress. We are currently requesting comments on its contents as we complete the final version of this paper. Please send your comments to jmichaels@g2ft.com. We look forward to hearing from you.

g2ft.com appears to be a tax protester site.

I'm all in favor of civil disobedience to right wrongs, but the reference is not to the set of court rulings originally implied.

PJW

I pulled that link from a quick search of Bogleheads. Here is a conversation in which I referenced specific cases.

http://www.bogleheads.org/forum/viewtop ... st=1592699

[Spirit Rider]

I would bet that selling VG's S&P500 Index fund only to buy another company's S&P500 Index fund inside of 31 days would be considered "substantially identical" if the IRS wanted to pursue it.

The S&P index is a one of the arguable cases. However, all S&P 500 index funds have tracking error and tax experts have taken the position that they are not substantially identical. Other experts dismiss this position. Personally, I wouldn't want to be the test case on this.

Total Market index is another situation. The tracking error is more substantial. even funds based on the same index have different number of companies in their index at any given time. Many tax experts consider these not substantially identical, although there are a few holdouts. This is maybe a little risky.

My common tax loss harvest move is Total Market vs. S&P 500 (80%) and Extended Market (20%) back and forth. I feel this is entirely defensible. Did this in 2000 - 2002 and 2007 - 2009. I feel it is a pretty big leap from substantially identical to effectively similar.

[iceport]

"Substantially identical" is such a wonderfully illogical combination of words. In practice it happens that "identical" applies in real effect and "substantially identical" exists in a never-never land that has never been used by the IRS to tag someone with a mutual fund wash sale.

PS The funds recommended above are fine, of course.

All true.

The way I see it, the letter of the law was written to allow violations of the spirit of the law, legally.

Fairmark.com does an admiral job of explaining the spirit of the law.

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. You can't report a loss for tax purposes without changing your investment position.

Substantially Identical Securities

And here's a suggested test of "substantially identical:"

The point of the wash sale rule is to determine whether you've changed your position relative to the market. If you can lay the price graph for your new investment on top of the price graph for the old one and never see a significant disparity (as would be the case for two high quality S&P 500 funds), the investments should be considered substantially identical for purposes of the wash sale rule.

Well, that speaks to the presumed intent of the wash sale rule. In the real world, as dbr points out, the term substantially identical is vague enough to allow law-abiding taxpayers to practically eliminate the risk associated with the sale and re-purchase of a portfolio position filled by a mutual fund.

[Wagnerjb]

From a post I made several years ago:

Substantially identical securities. Two issues of U.S. Treasury 2 1/4 percent bonds which differ slightly only as to first call, maturity and
interest payment dates, are substantially identical securities within the meaning of the wash sales provisions. Consequently, loss sustained upon sale of bonds of one issue followed by purchase of the other within the 61-day period will not be allowed. §§39.118–1, 1.1091–1. (Sec. 118, ’39 Code; Sec. 1091, ’86 Code.) Rev. Rul. 58-211, 1958-1 C.B. 529.


Substantially identical--bonds
An important case for determining whether two bonds are substantially identical is Hanlin.

In its decision, the court stated that substantially identical means "something less than precise correspondence will suffice to make the transaction a wash sale." The court also noted the legislative history of the wash-sale rules does not define the "something less." The court concluded that a "change in [economic] position" is the determining factor in deciding if the loss is "fictitious" and, therefore, disallowed under the wash-sale rules. Basically, if two investments have different characteristics that would affect the investment decision of an investor, the investments would not be considered substantially identical.


Futures Contracts. GCM 38369 (referenced in 39551) says that treasury futures are considered “substantially identical” to treasuries for the purpose of 1091.

[Phineas J. Whoopee]

Andy,

It took some effort to track things down among the references to threads with references to threads with references, but between all of them you did post enough information for me to find and read at least a few decisions.

I concede the point that securities with different CUSIPs may be substantially identical according to case law.

PJW

[OcotalNica]

Substantially Identical: here is a new one for everyone out there. My research has revealed that preferred stock of one company as compared to common stock of that same company are substantially different because the common stock usually has voting rights and the preferred does not.

HOWEVER, what about different classes of common stock? For example, Under Armour has class A and class C shares. The class A shares have voting rights, and the class C shares do not. If I sell one and buy the other immediately, does or doesn't that constitute a wash sale?

There is absolutely nothing on the Internet with respect to wash sales being applicable to different classes of common stock.

[Wagnerjb]

Substantially Identical: here is a new one for everyone out there. My research has revealed that preferred stock of one company as compared to common stock of that same company are substantially different because the common stock usually has voting rights and the preferred does not.

Could you share with us the specifics of your research? Maybe the specific cases and specific circumstances? What reasons do the courts give for saying that Preferred is not substantially identical to common?

For example, Under Armour has class A and class C shares. The class A shares have voting rights, and the class C shares do not.

If the reason that Preferred isn't substantially identical to common is truly due to voting rights (and not different dividends and rights in bankruptcy), then it sure seems that different classes of stock would be treated similarly. But I wonder if the "substance" differences between preferred and common aren't deeper than just voting rights.

Best wishes.

[Tanelorn]

HOWEVER, what about different classes of common stock? For example, Under Armour has class A and class C shares. The class A shares have voting rights, and the class C shares do not. If I sell one and buy the other immediately, does or doesn't that constitute a wash sale?

Unless they announce their merging the share classes, I think they're still different. Sure, voting rights are different and do matter for valuation sometimes (for example, a recent company I saw merged their share classes while giving 1.3 basic shares in exchange for the super voting ones). But forget all that - look at the charts of UA vs UA-C now UAA. They're are very different at times, sometimes by 5-10%. No one is going to believe you were taking no risk swapping one for the other.