Tax Rules for ETF Losses - Fidelity (2024)

Exchange-traded funds (ETFs) have some features of both individual stocks and mutual funds, but are unique investment vehicles. Investors buy shares in ETFs just like they would buy stock in corporations. They hope to make a profit from these purchases, but things don’t always work out. What happens if you suffer a loss when you sell your ETF shares?

Tax loss rules

Losses in ETFs usually are treated just like losses on stock sales, which generate capital losses. The losses are either short term or long term, depending on how long you owned the shares.

  • If you held them for one year or less, the loss is short term
  • If more than one year, the loss is long term.

These capital losses can be used to offset capital gains (from any investments, not just ETFs) and up to $3,000 of ordinary income ($1,500 for married persons filing separately). Capital losses in excess of these limits can be carried forward and used in future years. There is no limit on the years that the excess losses can be carried forward.

Harvesting losses

One of the opportunities that holding ETF shares presents is the ability to cherry-pick shares to be sold for optimum tax results. For example, say an investor buys 100 shares of XYZ ETF in January 2022 for $100 a share and another 100 shares in February 2024 for $150 a share. When the price of the shares drops to $90, the investor opts to sell half of the holdings. By designating that the February 2024 lot should be sold, the investor has maximized the loss ([$150 - $90] x 100 shares).

For tax purposes, in order that the correct basis for the lot be used in determining the loss, the investor must identify to the broker the shares that will be sold and receive written confirmation of the specification within a reasonable time. In the absence of such identification, it is assumed for tax purposes that the first shares acquired are the first shares sold. In the example above, this would mean that the January 2022 shares with a basis of $100 each would have been sold, minimizing the tax loss that the investor can recognize.

Watch the wash sale rule

If you buy substantially identical security within 30 days before or after a sale at a loss, you are subject to the wash sale rule. This prevents you from claiming the loss at this time. The wash sale rule also applies to acquiring a substantially identical security in a taxable exchange or acquiring a contract or option to buy a substantially equal security.

The tax law does not define substantially identical security, but it’s clear that buying and selling the same security meets the definition. For example, if you sell shares in the XYZ ETF at a loss and buy it back within the wash sale period, you cannot take the loss now. There has been no IRS ruling on whether ETFs from two different companies that track the same index are considered substantially identical.

ETFs can be used to avoid the wash sale rule while maintaining a similar investment holding. This is because ETFs typically are an index for a sector or other group of stocks and are not substantially identical to a single stock. For example, if you sell the stock of a drug company, such as Pfizer, Merck, or Johnson & Johnson, at a loss and then buy an ETF that tracks the drug companies, the wash sale rule does not apply. Examples of ETFs in this sector include iShares Dow Jones U.S. Pharmaceuticals, PowerShares Dynamic Pharmaceuticals, and SPDR S&P Pharmaceuticals.

It could also be argued that a sale of mutual fund shares at a loss, followed by the purchase of an ETF that is similar to the mutual fund, is outside the wash sale ban. The ETF price usually reflects the prices of the stocks it holds, whereas mutual funds shares tracking similar holdings may not have the same underlying value. In addition, there are different fees or other charges associated with mutual funds versus ETFs.

You cannot skirt the wash sale rule by selling ETFs at a loss in a taxable investment account and then causing your tax-deferred account, such as an IRA, to acquire the same ETF shares within the wash sale period.

The loss that is disallowed under the wash sale rule does not disappear forever. You can adjust the basis of the newly acquired shares to reflect the loss that cannot be claimed now so that you can take it later, when you sell these shares.

Special treatment for certain ETF losses

Currency ETFs do not generate capital gains or losses, but rather ordinary income or losses. This means that losses on the sale of shares in these ETFs produce ordinary losses that can be used to offset ordinary income, such as wages and bank interest.

Conclusion

ETFs are acquired with the expectation of realizing an economic gain. However, if the price of the shares declines, investors may make a financial decision to take losses. Work with a knowledgeable tax advisor to optimize the effect of these losses.

Tax Rules for ETF Losses - Fidelity (2024)

FAQs

Will Fidelity answer tax questions? ›

Fidelity does not provide legal or tax advice.

Can you write off ETF losses? ›

Tax loss rules

Losses in ETFs usually are treated just like losses on stock sales, which generate capital losses. The losses are either short term or long term, depending on how long you owned the shares. If more than one year, the loss is long term.

What is the tax loophole of an ETF? ›

Thanks to the tax treatment of in-kind redemptions, ETFs typically record no gains at all. That means the tax hit from winning stock bets is postponed until the investor sells the ETF, a perk holders of mutual funds, hedge funds and individual brokerage accounts don't typically enjoy.

Why are capital losses limited to $3,000? ›

The $3,000 loss limit is the amount that can be offset against ordinary income. Above $3,000 is where things can get complicated.

Will the IRS answer tax questions? ›

The IRS helps taxpayers get forms and publications and answers a wide range of tax questions.

Does Fidelity tax loss harvest? ›

Tax Loss Harvesting with Fidelity is a strategic approach that allows investors to minimize taxable gains by offsetting them with tax-deductible losses. This results in enhanced portfolio performance and reduced tax liabilities.

Can you write off 100% of stock losses? ›

If you own a stock where the company has declared bankruptcy and the stock has become worthless, you can generally deduct the full amount of your loss on that stock — up to annual IRS limits with the ability to carry excess losses forward to future years.

Are stock losses 100% tax deductible? ›

You can deduct stock losses from other reported taxable income up to the maximum amount allowed by the IRS—up to $3,000 a year—if you have no capital gains to offset your capital losses or if the total net figure between your short- and long-term capital gains and losses is a negative number, representing an overall ...

Can I use more than $3000 capital loss carryover? ›

Capital losses that exceed capital gains in a year may be used to offset capital gains or as a deduction against ordinary income up to $3,000 in any one tax year. Net capital losses in excess of $3,000 can be carried forward indefinitely until the amount is exhausted.

How to avoid paying taxes on ETFs? ›

One common strategy is to close out positions that have losses before their one-year anniversary. You then keep positions that have gains for more than one year. This way, your gains receive long-term capital gains treatment, lowering your tax liability.

Do you pay taxes on ETFs if you don't sell them? ›

If you hold these investments in a tax-deferred account, you generally won't be taxed until you make a withdrawal, and the withdrawal will be taxed at your current ordinary income tax rate. If you invest in stocks and bonds via ETFs, you probably won't be in for many surprises.

Does the wash rule apply to ETFs? ›

Q: Which securities are covered by the wash sale rule? Generally, if a security, such as stocks, exchange-traded funds (ETFs), and mutual funds, has a CUSIP number (a unique nine-character identifier for a security), then it's most likely subject to the wash sale rule.

How can I claim more than 3,000 capital losses? ›

What happens if your losses exceed your gains? The IRS will let you deduct up to $3,000 of capital losses (or up to $1,500 if you and your spouse are filing separate tax returns). If you have any leftover losses, you can carry the amount forward and claim it on a future tax return.

How many years can you carry forward a tax loss? ›

How Long Can Losses Be Carried Forward? According to IRS tax loss carryforward rules, capital and net operating losses can be carried forward indefinitely.

Does Fidelity have tax advisors? ›

Fidelity does not provide legal or tax advice.

Does Fidelity report to the IRS? ›

The IRS Form 1099-B is part of the non-exempt Fidelity Tax Reporting Statement and is also part of the information that we are required to report to the IRS.

What do I need from Fidelity for taxes? ›

During tax season, Fidelity will issue two forms you will need for cost basis information:
  1. Form 1099-B (an IRS form)
  2. Supplemental Information form (a special form Fidelity prepares to help you)

Does Fidelity keep track of taxes? ›

For Fidelity's ETF, Fidelity calculates both Return After Taxes on Distributions and Return After Taxes on Distributions and Sale of Shares consistent with the SEC prescribed methodology for open-end management investment companies.

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