life cycle funds and wash sale rules?

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barberakb
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life cycle funds and wash sale rules?

Post by barberakb » Thu Mar 26, 2020 11:20 pm

If I sell say Vanguards 2035 fund take a loss and then buy 2050 is that a wash sale?

Thanks

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iceport
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Re: life cycle funds and wash sale rules?

Post by iceport » Thu Mar 26, 2020 11:30 pm

Interesting question, but I'd say definitely not. Although the 4 underlying holdings are currently the same, they are held in different proportions. And the funds are on two different glidepaths. That's enough to not be substantially identical if you ask me.

One of those two differences more or less disappears among the funds of the outer-most target years, though. Only the glidepaths are really different.
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rkhusky
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Re: life cycle funds and wash sale rules?

Post by rkhusky » Fri Mar 27, 2020 8:10 am

Although the IRS hasn't provided a standard for "substantially identical", I think that TR 2045 - TR 2065 would be "substantially identical", not identical but close enough.

mega317
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Re: life cycle funds and wash sale rules?

Post by mega317 » Fri Mar 27, 2020 8:28 am

I think only the most conservative of us would consider that a wash. Since there is no guidance from the IRS, you need to come to your own conclusion in good faith. If you decide it's not and the IRS somehow decides to make you the first person ever to be challenged, the very worst that would happen is your loss would be disallowed and you'd have to pay additional taxes owed, perhaps with a penalty that wouldn't be huge.
https://www.bogleheads.org/forum/viewtopic.php?t=6212

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iceport
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Re: life cycle funds and wash sale rules?

Post by iceport » Fri Mar 27, 2020 8:36 am

rkhusky wrote:
Fri Mar 27, 2020 8:10 am
Although the IRS hasn't provided a standard for "substantially identical", I think that TR 2045 - TR 2065 would be "substantially identical", not identical but close enough.
Interesting question, though, right?

I didn't want to render an opinion of the later target year funds. You make a valid point on the current AA. But the AA transitions happen on different schedules, including the introduction of TIPS at different times. If someone owns the fund as intended — and the funds are still around in 40 years!!! — they will produce different returns in future decades. However, within the wash sale period, they're practically identical. So it would be possible for an investor to TLH back and forth between them without risking a change in AA.
"Discipline matters more than allocation.” ─William Bernstein

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iceport
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Re: life cycle funds and wash sale rules?

Post by iceport » Fri Mar 27, 2020 8:42 am

barberakb wrote:
Thu Mar 26, 2020 11:20 pm
If I sell say Vanguards 2035 fund take a loss and then buy 2050 is that a wash sale?

Thanks
Regardless of the opinions offered above on wash sales, I guess we fell down on the job otherwise.

OP, a much better question for you to ask is whether it's appropriate to own a balanced fund (stocks and bonds) in a taxable account in the first place! The bond slices might be tiny now, but they grow over time, and they are not generally tax-efficient. Meanwhile, if you've built up a stockpile of unrealized capital gains, selling the funds later in the interest of tax-efficiency could be tax cost prohibitive.

You might want to take the TLH opportunity to also consider a different taxable fund option.
"Discipline matters more than allocation.” ─William Bernstein

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Re: life cycle funds and wash sale rules?

Post by rkhusky » Fri Mar 27, 2020 8:48 am

iceport wrote:
Fri Mar 27, 2020 8:36 am
So it would be possible for an investor to TLH back and forth between them without risking a change in AA.
I'm currently using the TR funds to rebalance in my tax-advantaged accounts to avoid Vanguard's frequent trading restrictions. Have only used one so far, but if we get another big drop I will need to use a second. There are other ways to avoid the restrictions, but this seems easier. Plus I can buy/sell US/Int'l at the same time. I think you suggested this previously. Thanks.

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Nate79
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Re: life cycle funds and wash sale rules?

Post by Nate79 » Fri Mar 27, 2020 10:40 am

No, the target date funds 2035 and 2050 are not substantially identical. They have different percentages of underlying holdings, different strategy and target stock/bond percentages, different return numbers, etc. Previous IRS guidance said that two different mutual funds can not be substantially identical but for these we do not need to even go that far.

I wouldn't worry a second about this.

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Re: life cycle funds and wash sale rules?

Post by ChrisBenn » Fri Mar 27, 2020 11:03 am

Nate79 wrote:
Fri Mar 27, 2020 10:40 am
No, the target date funds 2035 and 2050 are not substantially identical. They have different percentages of underlying holdings, different strategy and target stock/bond percentages, different return numbers, etc. Previous IRS guidance said that two different mutual funds can not be substantially identical but for these we do not need to even go that far.

I wouldn't worry a second about this.
Agreed on the 2035 vs 2050, but if it was 2050 vs 2055 (same current allocation) I wouldn't be comfortable doing it.
I hadn't seen the guidance you mentioned on mutual funds never being substantially identical - do you have a link?

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Re: life cycle funds and wash sale rules?

Post by alex_686 » Fri Mar 27, 2020 11:12 am

Nate79 wrote:
Fri Mar 27, 2020 10:40 am
No, the target date funds 2035 and 2050 are not substantially identical. They have different percentages of underlying holdings, different strategy and target stock/bond percentages, different return numbers, etc. Previous IRS guidance said that two different mutual funds can not be substantially identical but for these we do not need to even go that far.

I wouldn't worry a second about this.
I have done this professionally. The IRS if focused on the how close the different percentages between the underlying assets are. That is key, the rest is not. Yes, the IRS at one point had some verbiage about the exchange of mutual funds but they have dropped that language. The IRS has levied civil fines on wash sales between 2 separate funds back in the early 2000s. This was for a hedge fund with millions on the line and the wash sale went through a private fund created just for the hedge fund in the Caymend Islands, IIRC. The regs are written the same for individuals.

In short, it is a legitimate question. This could be a wash sale and the IRS refuses to give calcification. I would operate with good faith - why do you think that they are, or are not, substantially identical.

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Re: life cycle funds and wash sale rules?

Post by Makefile » Fri Mar 27, 2020 12:39 pm

alex_686 wrote:
Fri Mar 27, 2020 11:12 am
I have done this professionally. The IRS if focused on the how close the different percentages between the underlying assets are. That is key, the rest is not. Yes, the IRS at one point had some verbiage about the exchange of mutual funds but they have dropped that language. The IRS has levied civil fines on wash sales between 2 separate funds back in the early 2000s. This was for a hedge fund with millions on the line and the wash sale went through a private fund created just for the hedge fund in the Caymend Islands, IIRC. The regs are written the same for individuals.

In short, it is a legitimate question. This could be a wash sale and the IRS refuses to give calcification. I would operate with good faith - why do you think that they are, or are not, substantially identical.
It is always interesting to read your posts about the behind the scenes management of funds. You do seem among the most cautious on the forum for the substantially identical definition. I wonder if the robo-advisor trend and their advertising automatic tax-loss harvesting between ETFs is "waving the red flag in front of the bull," so to speak, and if that will someday lead to clarification. It does seem like two ETFs being equivalent for asset allocation purposes, yet different for tax purposes, is having your cake and eating it too. If the IRS were to become more aggressive on this against individual investors, it will be quite messy as I suspect many of the users of those robo platforms have no idea what is going on behind the scenes.

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Re: life cycle funds and wash sale rules?

Post by alex_686 » Fri Mar 27, 2020 12:51 pm

Makefile wrote:
Fri Mar 27, 2020 12:39 pm
It is always interesting to read your posts about the behind the scenes management of funds. You do seem among the most cautious on the forum for the substantially identical definition. ... It does seem like two ETFs being equivalent for asset allocation purposes, yet different for tax purposes, is having your cake and eating it too.
I always struggle with this a bit. 2 bits.

I spend a good chunk of 10 years of my life on this issue. My ex-coworkers have attended week long conferences on various constructive sales rules. I have had my process audited by the IRS. That being said, I worked at a mutual fund family that was big enough that the IRS actually had their own office on my floor. Do the same rules apply to both big and small? Yes. Could we bring in a shoebox full of receipts for our annual review? No. They actually reviewed our processes prior to us submitting our tax forms. Could you get away with a shoebox? Probably yes.

Which takes me to my second point. I know the rules - and the great grey areas. It really bugs me when somebody lays out a clear back & white answer when it falls squarely in the grey area. I hate to squash simple answers for complex vague answers, but that is the lay of the land. The chance that somebody is actually going to get call out on this is low. It is a complex issue that I doubt most IRS auditors would deal with on personal returns. I honestly don't know how a typical individual would go about trying to prove one way or another about the substantially identical definition.

Just .... lets not dumb things down and stick with the truth - o.k.?

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Nate79
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Re: life cycle funds and wash sale rules?

Post by Nate79 » Fri Mar 27, 2020 1:17 pm

The IRS is welcome to provide guidance on this. Today they are silent in the face of millions of transactions. Until then this is still speculation that even any mutual fund can be substantially identical to another one. The only guidance we had (that no mutual fund can be substantially identical), even though retracted flies in the face of the ultra conservative opinions thrown around on here.

The general opinion is that if they do not track the same index or they have different underlying holdings then they are not substantially identical. Any other opinion is pretty far from the consensus and in my opinion far more conservative than needed.

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Re: life cycle funds and wash sale rules?

Post by mega317 » Fri Mar 27, 2020 1:23 pm

alex_686 wrote:
Fri Mar 27, 2020 12:51 pm
It really bugs me when somebody lays out a clear back & white answer when it falls squarely in the grey area. I hate to squash simple answers for complex vague answers, but that is the lay of the land.
I think you and I basically disagree on this issue but I agree with the above. It's not black and white because it hasn't been defined, so there can be no simple answers. But on the other hand, "we don't know because there is no guidance" is pretty simple.
https://www.bogleheads.org/forum/viewtopic.php?t=6212

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Re: life cycle funds and wash sale rules?

Post by alex_686 » Fri Mar 27, 2020 1:32 pm

mega317 wrote:
Fri Mar 27, 2020 1:23 pm
But on the other hand, "we don't know because there is no guidance" is pretty simple.
I think we can agree on that. Actually, a ex-employee or the IRS made that exact same point, likening the IRS standpoint to the FBI standpoint on fraud. They will never ever define what fraud is because as soon as they do somebody will figure out how to game the system. She told me that the IRS has no intention of every giving out guidance. I suspect that was one the reasons why the exchange between mutual fund language was drop from the IRS publications.

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iceport
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Re: life cycle funds and wash sale rules?

Post by iceport » Fri Mar 27, 2020 1:41 pm

Nate79, you really like pushing the limits on this. :—)
Nate79 wrote:
Fri Mar 27, 2020 10:40 am
They have different percentages of underlying holdings, different strategy and target stock/bond percentages, different return numbers, etc.
Different percentages of the underlying holdings? :thumbsup

Different strategy? Wait, what? They follow absolutely identical strategies. They're just at different points along that one single strategy. :thumbsdown

Different target stock/bond percentages? Well, now you're just double-counting the first difference, to make it seem like there are more. :thumbsdown

Different returns? Yes, and very significant, IMHO! :thumbsup
Nate79 wrote:
Fri Mar 27, 2020 10:40 am
Previous IRS guidance said that two different mutual funds can not be substantially identical but for these we do not need to even go that far.
Nate79 wrote:
Fri Mar 27, 2020 1:17 pm
The only guidance we had (that no mutual fund can be substantially identical), even though retracted flies in the face of the ultra conservative opinions thrown around on here.
The problem here is that even your cherished Pub 550 passage, long abandoned by the IRS, said nothing of the sort. As was pointed out recently, the actual text read like this:
Substantially Identical. In determining whether the shares are substantially identical, you must consider all the facts and circumstances. Ordinarily, shares issued by one mutual fund are not considered to be substantially identical to shares issued by another mutual fund.
That's nothing like saying two different mutual funds cannot be substantially identical.
"Discipline matters more than allocation.” ─William Bernstein

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Re: life cycle funds and wash sale rules?

Post by alex_686 » Fri Mar 27, 2020 1:46 pm

iceport wrote:
Fri Mar 27, 2020 1:41 pm
Different percentages of the underlying holdings? :thumbsup

Different strategy? Wait, what? They follow absolutely identical strategies. They're just at different points along that one single strategy. :thumbsdown

Different target stock/bond percentages? Well, now you're just double-counting the first difference, to make it seem like there are more. :thumbsdown

Different returns? Yes, and very significant, IMHO! :thumbsup
So, here is my question. Where did you come up with this test? Is this something you created or did you get it from someplace reputable.

Because as somebody who had to do this professionally, the only item that the IRS was interested in was the first. And would would have kicked back a "kind of" and they would have asked for more documentation.

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Re: life cycle funds and wash sale rules?

Post by alex_686 » Fri Mar 27, 2020 1:53 pm

Sigh, in posts like this I sometimes feel that the quality of advice is that of sex ed. You have got the locker room with insinuations, guesses, and rumors. Then you have the adults, who won't say anything constructive on the matter. Sigh. Let me ask 3 questions.

1. Is it legal to drive 5 MPH above the speed limit.
2. Has anybody actually been caught and ticked going above 5 MPH.
3. Since nobody has actually been ticked going above 5 MPH, does this mean it is legal to drive 5 MPH.

Or maybe we should refer back to the good old days of when Montana had a prima facie speed limit. No speed limit was posted but the cops could still pull you over if you were driving at a unsafe speed.

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iceport
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Re: life cycle funds and wash sale rules?

Post by iceport » Fri Mar 27, 2020 2:18 pm

alex_686 wrote:
Fri Mar 27, 2020 1:46 pm
iceport wrote:
Fri Mar 27, 2020 1:41 pm
Different percentages of the underlying holdings? :thumbsup

Different strategy? Wait, what? They follow absolutely identical strategies. They're just at different points along that one single strategy. :thumbsdown

Different target stock/bond percentages? Well, now you're just double-counting the first difference, to make it seem like there are more. :thumbsdown

Different returns? Yes, and very significant, IMHO! :thumbsup
So, here is my question. Where did you come up with this test? Is this something you created or did you get it from someplace reputable.

Because as somebody who had to do this professionally, the only item that the IRS was interested in was the first. And would would have kicked back a "kind of" and they would have asked for more documentation.
Which test, the last one? To me, the fact that the two funds have historically produced different returns is significant. The reason goes back to something you said earlier:
alex_686 wrote:
Fri Mar 27, 2020 11:12 am
In short, it is a legitimate question. This could be a wash sale and the IRS refuses to give calcification. I would operate with good faith - why do you think that they are, or are not, substantially identical.
I greatly appreciate your experience and knowledge on this topic, alex_686. But I also appreciate your ethics. So many of these grey area questions boil down to whether or not one is interested in acting in good faith. I have always assumed that if good faith can be demonstrated, the IRS might be inclined to be more forgiving. (Perhaps you could weigh in on that.) Those who want to push the boundaries can often appear to not be acting in good faith, but rather seem to be trying to see how much they can get away with.

I think the first place I read that historic returns might be considered a valid factor in assessing substantially identical was something Kaye Thomas wrote at Fairmark.com. (And Michael Kitces might have made a similar comment at some point?) Thomas has a very cautious approach to the question. The comment went something like... oh heck, here it is:
My feeling is that those differences aren’t enough to prevent the two funds from being 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.
Sure, this is just one more person's opinion. The thing is, it makes a ton of sense. More to the point, it is a good faith attempt to interpret the rule. It's another way to measure if there's any risk involved to the investor in making the substitution, any "change in economic position," as was noted to be an important test in a prior court ruling, in 1939 I think.

According to this substantially identical test, many of the TLH pairs advocated widely here and elsewhere would fail.
"Discipline matters more than allocation.” ─William Bernstein

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Re: life cycle funds and wash sale rules?

Post by jjface » Fri Mar 27, 2020 2:35 pm

Nobody knows. But the target retirement series are a wrapper and contain the same underlying funds in different proportions. If I was the IRS and wanted to pursue this I could easily agrue that we can look through the wrapper and argue that since tr 2055 has 53.5% total stock, and tr 2035 has 44.9% total stock then 44.9% is a wash sale and you can have the 8.6% as not. Similarly for the other funds. In the end about 80% is overlap so there could be justification to have 80% as a wash.

Of course you could argue that the underlying funds are not important. And the IRS just showed that the funds themselves are not substantially identical since there is only 80% overlap. Asvisors too wouldn't suggest you invest in tr 2035 or tr 2055. They are aimed at different people.

If it came to a fight would you be willing to take the time and money to fight it? At the end it is not who is right but the chance of getting into a fight (is this a significant position) and your ability to fight (do you have the time and resources) as well how.confident you are that you can win (seems like a defensible position to me that it is not a wash)
Last edited by jjface on Fri Mar 27, 2020 2:39 pm, edited 1 time in total.

mega317
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Re: life cycle funds and wash sale rules?

Post by mega317 » Fri Mar 27, 2020 2:36 pm

Pretty much every post in this thread, including and maybe especially mine, is not helpful since the IRS has not given us guidance. Past returns might matter but no one has told us that. Percentage correlation or overlap might matter, or not.

I don't think the 5 MPH analogy holds because there is a clear law there, the enforcement is a separate question. We aren't allowed, and shouldn't, talk about breaking any rules. No one is posting "should I drive 70.1 MPH because I won't be pulled over?" This is legitimate good faith disagreement about an ambiguity. (I imagine internet car forums in Montana back in the day would have had endless arguments about speeding.) And no one ever posts "how do I get away with claiming a loss on a wash sale" knowing it's not allowed. Everyone is operating in good faith.

One person's opinion doesn't matter no matter how much it makes sense. Except the person claiming the loss on his/her taxes.

I also enjoy how often the OP disappears from these threads. Like eh thanks anyway.
https://www.bogleheads.org/forum/viewtopic.php?t=6212

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Re: life cycle funds and wash sale rules?

Post by iceport » Fri Mar 27, 2020 2:47 pm

mega317 wrote:
Fri Mar 27, 2020 2:36 pm
And no one ever posts "how do I get away with claiming a loss on a wash sale" knowing it's not allowed. Everyone is operating in good faith.
I respectfully disagree on this. In order to operate in good faith, it's necessary to consider what the intent of the law is. There are lots of folks here that claim that intent is completely irrelevant. How can there be good faith when there's no acknowledgement that there was any purpose to the rule other than to make accounting busywork?

They say it's perfectly fine to exchange between two S&P 500 index funds. I say, "Then why did they even make the rule?" They say, "It doesn't matter."

Well, that's a convenient opinion. If the rule is intended to prevent a taxpayer form claiming a loss while staying invested, and that's exactly what you want to get away with, it's not helpful to remember the purpose. But ignoring that purpose is not acting in good faith.
mega317 wrote:
Fri Mar 27, 2020 2:36 pm
I also enjoy how often the OP disappears from these threads. Like eh thanks anyway.
Same here. 8-) I think we scared off the poor OP. Didn't know what they were getting them self into. :shock:
"Discipline matters more than allocation.” ─William Bernstein

mega317
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Re: life cycle funds and wash sale rules?

Post by mega317 » Fri Mar 27, 2020 2:57 pm

I don't wholly disagree with that. It seems like your impression of the intent is to "prevent a taxpayer from claiming a loss while staying invested" which I broadly agree with. But if the intent is clear, it's still not clear to what degree staying invested is not ok. Would you suggest any loss should be accompanied by a movement to a different asset class? And as I have posted on other threads recently, why 30 days? Most 30 day periods the market doesn't do much.

It would be extremely easy for them to define some parameters. It would also be possible, maybe not easy just because of manpower, for them to start enforcing whatever they decide their definition is without telling us. They have done neither.
https://www.bogleheads.org/forum/viewtopic.php?t=6212

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Re: life cycle funds and wash sale rules?

Post by iceport » Fri Mar 27, 2020 3:06 pm

mega317 wrote:
Fri Mar 27, 2020 2:57 pm
I don't wholly disagree with that. It seems like your impression of the intent is to "prevent a taxpayer from claiming a loss while staying invested" which I broadly agree with. But if the intent is clear, it's still not clear to what degree staying invested is not ok. Would you suggest any loss should be accompanied by a movement to a different asset class? And as I have posted on other threads recently, why 30 days? Most 30 day periods the market doesn't do much.

It would be extremely easy for them to define some parameters. It would also be possible, maybe not easy just because of manpower, for them to start enforcing whatever they decide their definition is without telling us. They have done neither.
I agree with all of the above. But that's different than saying everyone operates in good faith. Struggling with intellectually honest explorations of the built-in ambiguity is operating in good faith, and reasonable minds may disagree. But saying the law's intent is wholly irrelevant is not. I'm certain the IRS and any judge involved in a suit would not consider the intent of the law irrelevant.

BTW, my "impression" was paraphrased directly from an IRS General Council Memo:
The "purpose of the wash sales provisions is to prevent tax manipulation by a taxpayer who
attempts to recognize a loss on the sale of 'securities' while maintaining an identical or nearly identical
investment position."
‖ I.R.S. Gen. Couns. Mem. 38,369 (May 9, 1980).
"Discipline matters more than allocation.” ─William Bernstein

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Re: life cycle funds and wash sale rules?

Post by mega317 » Fri Mar 27, 2020 3:11 pm

We have come to an agreement. I will have to be more mindful in future threads, if there are any har har, how the OPs are considering intent. See you there :D
https://www.bogleheads.org/forum/viewtopic.php?t=6212

ChrisBenn
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Re: life cycle funds and wash sale rules?

Post by ChrisBenn » Fri Mar 27, 2020 3:33 pm

alex_686 wrote:
Fri Mar 27, 2020 1:46 pm
(...)
Because as somebody who had to do this professionally, the only item that the IRS was interested in was the first. And would would have kicked back a "kind of" and they would have asked for more documentation.
Did the economic substance doctrine ever come up in your discussions? It would seem (huge caveat of not a lawyer/tax professional) that this basically disallows the practice of tax loss harvesting period - you would only get the loss if you were making the transaction for other, non tax related reasons? What am I missing here?

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Re: life cycle funds and wash sale rules?

Post by alex_686 » Fri Mar 27, 2020 3:35 pm

iceport wrote:
Fri Mar 27, 2020 2:18 pm
alex_686 wrote:
Fri Mar 27, 2020 1:46 pm
iceport wrote:
Fri Mar 27, 2020 1:41 pm
Different percentages of the underlying holdings? :thumbsup

Different strategy? Wait, what? They follow absolutely identical strategies. They're just at different points along that one single strategy. :thumbsdown

Different target stock/bond percentages? Well, now you're just double-counting the first difference, to make it seem like there are more. :thumbsdown

Different returns? Yes, and very significant, IMHO! :thumbsup
So, here is my question. Where did you come up with this test? Is this something you created or did you get it from someplace reputable.

Because as somebody who had to do this professionally, the only item that the IRS was interested in was the first. And would would have kicked back a "kind of" and they would have asked for more documentation.
Which test, the last one? To me, the fact that the two funds have historically produced different returns is significant. The reason goes back to something you said earlier:
alex_686 wrote:
Fri Mar 27, 2020 11:12 am
In short, it is a legitimate question. This could be a wash sale and the IRS refuses to give calcification. I would operate with good faith - why do you think that they are, or are not, substantially identical.
I greatly appreciate your experience and knowledge on this topic, alex_686. But I also appreciate your ethics. So many of these grey area questions boil down to whether or not one is interested in acting in good faith. I have always assumed that if good faith can be demonstrated, the IRS might be inclined to be more forgiving. (Perhaps you could weigh in on that.) Those who want to push the boundaries can often appear to not be acting in good faith, but rather seem to be trying to see how much they can get away with.

I think the first place I read that historic returns might be considered a valid factor in assessing substantially identical was something Kaye Thomas wrote at Fairmark.com. (And Michael Kitces might have made a similar comment at some point?) Thomas has a very cautious approach to the question. The comment went something like... oh heck, here it is:
My feeling is that those differences aren’t enough to prevent the two funds from being 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.
Sure, this is just one more person's opinion. The thing is, it makes a ton of sense. More to the point, it is a good faith attempt to interpret the rule. It's another way to measure if there's any risk involved to the investor in making the substitution, any "change in economic position," as was noted to be an important test in a prior court ruling, in 1939 I think.

According to this substantially identical test, many of the TLH pairs advocated widely here and elsewhere would fail.
So let me step back for a second.

When I say "tests" I am thinking about this in a algorithmic way. For example, this to be a wash sale it has to meet 1 or the 4 tests. I think this is the way that the IRS thinks about these issues. Then again, I was surrounded by people who were trying to design a system to handle literally millions of possible wash sales in a institutional setting.

Test #1 - Overlap. This is the only one that I know of.

Test #2 - Different Strategy. I don't think this is a valid test. There is no objective measure. And I have seen Portfolio Managers ignore or change strategies on the fly.

Test #3 - eh. There was a critical course back in the 30s where a investor swapped a municipal bond for a different bond. The only difference was the maturities were 3 months apart. It was declared a wash sale. And there was another court case where they swapped municipals of the same maturity but with different call options. Not a wash sale.

Test #4 - Different Returns.I have read the Michael Kitces article and I disagree. See #3 - bonds with the same returns from from different municipalities and not the same. Now consider this situation for a second. I sell 100k of the SPY. I buy 50k of a x2 leverage SPY ETF and 50k of a small cap index. Have I created a wash sale? My fund family said yes. After all the direct exposure of 100k SPY was identical to the 50k x2 leverage fund if we looked through the fund. And while the IRS never said this was the right choice they strongly hinted it was. They never asked about returns.

There is a better story out there with a Goldman Sachs bond that was convertible into MSFT. That was a bugbear. Sometimes it was, sometimes it was not.

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Re: life cycle funds and wash sale rules?

Post by alex_686 » Fri Mar 27, 2020 3:39 pm

ChrisBenn wrote:
Fri Mar 27, 2020 3:33 pm
alex_686 wrote:
Fri Mar 27, 2020 1:46 pm
(...)
Because as somebody who had to do this professionally, the only item that the IRS was interested in was the first. And would would have kicked back a "kind of" and they would have asked for more documentation.
Did the economic substance doctrine ever come up in your discussions? It would seem (huge caveat of not a lawyer/tax professional) that this basically disallows the practice of tax loss harvesting period - you would only get the loss if you were making the transaction for other, non tax related reasons? What am I missing here?
Define economic substance? Did they care about past correlations or shared factors? No. They were very focused on the actual instruments legal structure. And any underlying securities' legal structure. IIRC, we did consider the 2 different classes of Volkswagen shares to be similar, since the primary difference was one of voting rights even though the correlation between the 2 shares was kind of loose.

rkhusky
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Re: life cycle funds and wash sale rules?

Post by rkhusky » Fri Mar 27, 2020 3:40 pm

iceport wrote:
Fri Mar 27, 2020 2:18 pm
I think the first place I read that historic returns might be considered a valid factor in assessing substantially identical was something Kaye Thomas wrote at Fairmark.com. (And Michael Kitces might have made a similar comment at some point?) Thomas has a very cautious approach to the question. The comment went something like... oh heck, here it is:
My feeling is that those differences aren’t enough to prevent the two funds from being 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.
I think the similar return thing is a red herring because the IRS has already ruled that two bonds with the exact same interest rate were not substantially identical because of other differences in the bonds.

So, just because two funds have very similar returns does not mean that they are substantially identical if the underlying holdings are sufficiently different.

ChrisBenn
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Re: life cycle funds and wash sale rules?

Post by ChrisBenn » Fri Mar 27, 2020 3:50 pm

alex_686 wrote:
Fri Mar 27, 2020 3:39 pm
ChrisBenn wrote:
Fri Mar 27, 2020 3:33 pm
alex_686 wrote:
Fri Mar 27, 2020 1:46 pm
(...)
Because as somebody who had to do this professionally, the only item that the IRS was interested in was the first. And would would have kicked back a "kind of" and they would have asked for more documentation.
Did the economic substance doctrine ever come up in your discussions? It would seem (huge caveat of not a lawyer/tax professional) that this basically disallows the practice of tax loss harvesting period - you would only get the loss if you were making the transaction for other, non tax related reasons? What am I missing here?
Define economic substance? Did they care about past correlations or shared factors? No. They were very focused on the actual instruments legal structure. And any underlying securities' legal structure. IIRC, we did consider the 2 different classes of Volkswagen shares to be similar, since the primary difference was one of voting rights even though the correlation between the 2 shares was kind of loose.

As separate from the wash sale rules, but impacting? the practice of tax loss harvesting:
https://www.irs.gov/pub/irs-drop/n-14-58.pdf
Section 7701(o)(5)(A) defines "economic substance doctrine" as the common-law doctrine that disallows tax benefits under subtitle A of the Internal Revenue Code if the transaction that produces those benefits lacks economic substance or a business purpose. Under section 7701(o)(1), a transaction has economic substance if: (1) the transaction changes in a meaningful way (apart from Federal income tax effects) the taxpayer’s economic position; and (2) the taxpayer has a substantial purpose (apart from Federal income tax effects) for entering into such transaction.
It seems like tax loss harvesting losses would be disallowed unless one could articulate a reason for the transaction other than tax loss harvesting? pub 550 references it also, and lays out a 20% penalty for underpayments due to claiming losses disallowed by this doctrine.

alex_686
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Re: life cycle funds and wash sale rules?

Post by alex_686 » Fri Mar 27, 2020 3:54 pm

ChrisBenn wrote:
Fri Mar 27, 2020 3:50 pm
It seems like tax loss harvesting losses would be disallowed unless one could articulate a reason for the transaction other than tax loss harvesting? pub 550 references it also, and lays out a 20% penalty for underpayments due to claiming losses disallowed by this doctrine.
You have it right. I was getting to far into the weeds.

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iceport
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Re: life cycle funds and wash sale rules?

Post by iceport » Fri Mar 27, 2020 4:11 pm

alex_686 wrote:
Fri Mar 27, 2020 3:54 pm
ChrisBenn wrote:
Fri Mar 27, 2020 3:50 pm
It seems like tax loss harvesting losses would be disallowed unless one could articulate a reason for the transaction other than tax loss harvesting? pub 550 references it also, and lays out a 20% penalty for underpayments due to claiming losses disallowed by this doctrine.
You have it right. I was getting to far into the weeds.
OK, you guys are losing me a bit here. I understand (I think...) what you are saying. And there's perfect logic to it.

But what are the real world ramifications? alex_686, in all your professional dealings with the question of wash sales, wasn't it typically in connection with some form of TLH? And if so, didn't all parties involved, regulatory and otherwise, know exactly what the underlying intent of the transaction was?
"Discipline matters more than allocation.” ─William Bernstein

ChrisBenn
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Re: life cycle funds and wash sale rules?

Post by ChrisBenn » Fri Mar 27, 2020 4:16 pm

Yikes - so it seems like TLH as discussed in this forum and on the wiki (https://www.bogleheads.org/wiki/Tax_loss_harvesting) is actually a potential violation of tax code. At a minimum this adds another layer to the good faith piece, in that now someone has to articulate why (other than taxes) they moved from vti to voo, and then back to vti 31 days later. That seems like a tough sell.

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iceport
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Re: life cycle funds and wash sale rules?

Post by iceport » Fri Mar 27, 2020 4:17 pm

ChrisBenn wrote:
Fri Mar 27, 2020 4:16 pm
Yikes - so it seems like TLH as discussed in this forum and on the wiki (https://www.bogleheads.org/wiki/Tax_loss_harvesting) is actually a violation of tax code. At a minimum this adds another layer to the good faith piece, in that now someone has to articulate why (other than taxes) they moved from vti to voo, and then back to vti 31 days later. That seems like a tough sell.
Right. And what about Wealthfront and Betterment? TLH is a central component of their whole business model...

I guess they would be the RADAR detector manufacturers of the finance industry: helping folks break the law, while not being responsible for it?
"Discipline matters more than allocation.” ─William Bernstein

alex_686
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Re: life cycle funds and wash sale rules?

Post by alex_686 » Fri Mar 27, 2020 4:31 pm

iceport wrote:
Fri Mar 27, 2020 4:11 pm
alex_686 wrote:
Fri Mar 27, 2020 3:54 pm
ChrisBenn wrote:
Fri Mar 27, 2020 3:50 pm
It seems like tax loss harvesting losses would be disallowed unless one could articulate a reason for the transaction other than tax loss harvesting? pub 550 references it also, and lays out a 20% penalty for underpayments due to claiming losses disallowed by this doctrine.
You have it right. I was getting to far into the weeds.
OK, you guys are losing me a bit here. I understand (I think...) what you are saying. And there's perfect logic to it.

But what are the real world ramifications? alex_686, in all your professional dealings with the question of wash sales, wasn't it typically in connection with some form of TLH? And if so, didn't all parties involved, regulatory and otherwise, know exactly what the underlying intent of the transaction was?
For our organization it never mattered. The portfolio manager, like most mutual fund portfolio managers, were paid on risk adjusted returns. They did not care about taxes so this never really came into play. And our accountants were in a different department. So there really never was a motive or a reason to collude.

From my experience, the only time the economic issue comes into play is where the IRS thinks that the tax payer is trying to abuse the system.

EDIT: Unless you mean the fact that we did a fair amount of look through. For example, our portfolio managers like to sell off securities in a index and then buy futures on that index. So these trades were economically equivalent. You know what - let me think about this a bit more and get back to you.

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Re: life cycle funds and wash sale rules?

Post by alex_686 » Fri Mar 27, 2020 5:16 pm

OK - take 2.

Yes, the law specifics that the trade has to be motivated primarily by economic reasons, not tax reasons.

First, there is the hard rules. You need to exchange one asset for another. The IRS is looking for hard objective criteria. They are looking at which legal entity issued the securities, which legal entity has recourse. They want to look through the security or contracts (options, futures, convertible debt, etc) to see what is underpinning the contract. Small changes in maturity don't seem to matter. Changes in call options or security features do. Lots of technical stuff here. A fair amount of grey area. Are 2 large cap domestic equity fund similar? Maybe - a grey area. Intention really does not come into play here.

To give a real life example, often one of our portfolio managers would unload large cap stocks - basically the S&P 500 over a period of a week or 2 and redeploy to something else. Then a large pile of cash would come in. To maintain their asset allocation they would then buy back large cap stocks or futures. What was their intent? Not to create wash sales, but there you go - wash sales.

Second, there is the intention. This is where you threw me off. Most of the interesting stories are around people trying to get around the law. For example, buy selling one portfolio and buy a fund. And the fund is a private fund with a client of 1 that follows a custom index that just happens to almost replicate - but not quite - the original portfolio. A blatant attempt to do a end run around the tax.

I hope this helps.

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barberakb
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Re: life cycle funds and wash sale rules?

Post by barberakb » Sat Mar 28, 2020 3:17 am

mega317 wrote:
Fri Mar 27, 2020 2:36 pm
Pretty much every post in this thread, including and maybe especially mine, is not helpful since the IRS has not given us guidance. Past returns might matter but no one has told us that. Percentage correlation or overlap might matter, or not.

I don't think the 5 MPH analogy holds because there is a clear law there, the enforcement is a separate question. We aren't allowed, and shouldn't, talk about breaking any rules. No one is posting "should I drive 70.1 MPH because I won't be pulled over?" This is legitimate good faith disagreement about an ambiguity. (I imagine internet car forums in Montana back in the day would have had endless arguments about speeding.) And no one ever posts "how do I get away with claiming a loss on a wash sale" knowing it's not allowed. Everyone is operating in good faith.

One person's opinion doesn't matter no matter how much it makes sense. Except the person claiming the loss on his/her taxes.

I also enjoy how often the OP disappears from these threads. Like eh thanks anyway.
Didn't disappear. I am sitting back and reading your guys comments. I honestly don't know the answer which is why I asked.

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Re: life cycle funds and wash sale rules?

Post by barberakb » Sat Mar 28, 2020 3:24 am

I would think though if I was say selling 2035 and moving to 2065 then in good faith I could say easily that I
am not maintaining an identical or nearly identical investment position.

Thanks for the info all

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Re: life cycle funds and wash sale rules?

Post by Bfwolf » Sat Mar 28, 2020 3:40 am

jjface wrote:
Fri Mar 27, 2020 2:35 pm
Nobody knows. But the target retirement series are a wrapper and contain the same underlying funds in different proportions. If I was the IRS and wanted to pursue this I could easily agrue that we can look through the wrapper and argue that since tr 2055 has 53.5% total stock, and tr 2035 has 44.9% total stock then 44.9% is a wash sale and you can have the 8.6% as not. Similarly for the other funds. In the end about 80% is overlap so there could be justification to have 80% as a wash.

Of course you could argue that the underlying funds are not important. And the IRS just showed that the funds themselves are not substantially identical since there is only 80% overlap. Asvisors too wouldn't suggest you invest in tr 2035 or tr 2055. They are aimed at different people.

If it came to a fight would you be willing to take the time and money to fight it? At the end it is not who is right but the chance of getting into a fight (is this a significant position) and your ability to fight (do you have the time and resources) as well how.confident you are that you can win (seems like a defensible position to me that it is not a wash)
You could make the same argument for 2 mutual funds that both own Apple as part of their holdings. Is the IRS going to disallow the wash sale on the overlapping Apple holdings?

IMO, it is absurd for an average investor to be worried about TR 2035 and 2055 being considered a wash sale.

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Re: life cycle funds and wash sale rules?

Post by iamblessed » Sat Mar 28, 2020 8:42 am

I don't think it is a wash because you can go from total stock to the 500 with no wash. These life cycle funds have less in common. I think a person could sell life cycle 2035 and move to 2040. I can't see how this would be a wash. Once the percentage of stocks or bonds change it is different.

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Re: life cycle funds and wash sale rules?

Post by ChrisBenn » Sat Mar 28, 2020 9:07 am

Bfwolf wrote:
Sat Mar 28, 2020 3:40 am
You could make the same argument for 2 mutual funds that both own Apple as part of their holdings. Is the IRS going to disallow the wash sale on the overlapping Apple holdings?

IMO, it is absurd for an average investor to be worried about TR 2035 and 2055 being considered a wash sale.
I think it was a pretty interesting question actually - and I think from the discussion it's pretty evident that the IRS hasn't (possibly intentionally) given clear guidance on what is substantially identical. 90/10 -> 89/11 vs. vs 85/15 -- where is the line? (They aren't drawing one).

It's also quite clear (IMO) that going from VTI -> VOO (quite common here) is probably a violation of the spirit of the law (since they track identically - and have very similar holdings). If it wasn't then what's the purpose of the wash sale rule to begin with.

Now as for being worried, I probably agree - I doubt an average retail investor is going to get audited over this - but I think understanding when you may be in a gray area, and what the borders of that gray area are is pretty important.

I also no longer believe tax loss harvesting is actually legal: viewtopic.php?f=10&t=309891

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Re: life cycle funds and wash sale rules?

Post by mega317 » Sat Mar 28, 2020 9:27 am

iamblessed wrote:
Sat Mar 28, 2020 8:42 am
I don't think it is a wash because you can go from total stock to the 500 with no wash.
But hasn't half of this thread been saying we don't know that to be true? So you can't necessarily use that to inform other wash determinations.
ChrisBenn wrote:
Sat Mar 28, 2020 9:07 am
It's also quite clear (IMO) that going from VTI -> VOO (quite common here) is probably a violation of the spirit of the law
I'm now also thinking that perhaps the spirit of the law doesn't care about you and me and was only interested in big-time money. It's a possibilty. Once again, we don't know.
https://www.bogleheads.org/forum/viewtopic.php?t=6212

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Re: life cycle funds and wash sale rules?

Post by iceport » Sat Mar 28, 2020 9:32 am

barberakb wrote:
Sat Mar 28, 2020 3:24 am
I would think though if I was say selling 2035 and moving to 2065 then in good faith I could say easily that I
am not maintaining an identical or nearly identical investment position.

Thanks for the info all
I don't think anyone who's commented here would really disagree. The entire thread has mostly been arguing the degree of certainty of the answer.

But still, do you really want to own taxable bonds in a taxable account forever? If not, now is an excellent time to address the situation (and probably a really bad time not to).
"Discipline matters more than allocation.” ─William Bernstein

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iceport
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Re: life cycle funds and wash sale rules?

Post by iceport » Sat Mar 28, 2020 9:45 am

alex_686 wrote:
Fri Mar 27, 2020 5:16 pm
OK - take 2.
.
.
.
I hope this helps.
Thank you for that interesting glimpse into the technical workings of institutional portfolio management!

It helps in some respects, yet still leaves me confused in others. I'll come back later with more questions when I have more time, but just wanted to quickly thank you for your detailed reply.
"Discipline matters more than allocation.” ─William Bernstein

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