Is there a wash sale rule for ETFs?
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.
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 most ETFs, selling after less than a year is taxed as a short-term capital gain. ETFs held for longer than a year are taxed as long-term gains. If you sell an ETF, and buy the same (or a substantially similar) ETF after less than 30 days, you may be subject to the wash sale rule.
Note: Wash sales are in scope only if reported on Form 1099-B or on a brokerage or mutual fund statement. Click here for an explanation. A wash sale is the sale of securities at a loss and the acquisition of same (substantially identical) securities within 30 days of sale date (before or after).
Tax-loss harvesting is the process of selling securities at a loss to offset a capital gains tax liability in a very similar security. Using ETFs has made tax-loss harvesting easier because several ETF providers offer similar funds that track the same index but are constructed slightly differently.
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.
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. The ETF tax loophole works only on capital gains, though.
If you're interested in selling ETFs, you can do it at any time during regular stock market hours, just like a stock. You'll want to make sure you figure out the best time of day to sell your ETF and the best order type to use.
At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.
You can buy or sell ETFs any time the stock market. + read full definition is open. ETFs are traded throughout the day at the current market price. + read full definition.
Do wash sales trigger audits?
While in the short-term, they may avoid the wash sale loss problem, over the long-term, it will not work out well for the brokers or the clients. The IRS will probably audit some of their clients over wash sales and agents will likely propose tax changes, including tax liability, penalties and interest.
Be aware of the wash sale rule enforced by the IRS. The wash sale rule is important for investors reassessing their market positions and looking to sell and repurchase declining stocks to offset losses.
To avoid a wash sale, the investor can wait more than 30 days from the sale to purchase an identical or substantially identical investment or invest in exchange-traded or mutual funds with similar investments to the one sold.
ETFs are built to avoid the capital gains that result from turnover and redemptions. Investors buy or sell ETF shares on a stock exchange from other investors, not the fund. This avoids the need to raise cash to meet redemptions for small investors.
The ITA also includes the “superficial loss" rule, also known as the "30-day rule." This rule prevents an investor or their affiliated persons from deducting a capital loss realized as a result of the sale of a security when the same security is repurchased within 30 days before or after the sale [1].
Generally, ETFs will have a slight edge from a tax efficiency perspective. ETFs tend to distribute comparatively fewer capital gains to shareholders – these same gains are simply more challenging to manage efficiently from a mutual fund. Overall, VOO and VTI are considered to have the same level of tax efficiency.
| Mutual Funds | ETFs | |
|---|---|---|
| Trades executed: | Once per day, after market close | Throughout the trading day and during extended hours trading |
| Settlement period: | From 1 to 2 business days | 2 business days (trade date + 2) |
| Short sales allowed? | No | Yes |
| Limit and stop orders allowed? | No | Yes |
The IRS will disallow your loss, and you won't be able to claim a write-off on your tax return. You'll end up owing taxes on any income that you tried to offset with your wash sale.
It's important to be aware of the IRS wash-sale rule when reinvesting the funds. If you buy the same investment or any investment the IRS considers “substantially identical” within 30 days before or after you sold at a loss, you won't be able to claim the loss.
Vanguard Intermediate-Term Tax-Exempt Bond ETF is designed for tax-sensitive investors with an intermediate-term time horizon and a preference for passive management. The new ETF has an expense ratio of 0.08%, compared with the average expense ratio for competing funds of 0.37%1.
Do you pay taxes on ETFs every year?
Both mutual funds and ETFs generally are required to distribute capital gains to investors, which can potentially result in a significant tax cost annually.
However, like fees on mutual fund, those paid on ETFs are indirectly tax deductible because they reduce the net income flowed through to ETF investors to report on their tax returns. Other non-deductible expenses include: Interest on money borrowed to invest in investments that can only earn capital gains.
ETFs make a great pick for many investors who are starting out as well as for those who simply don't want to do all the legwork required to own individual stocks. Though it's possible to find the big winners among individual stocks, you have strong odds of doing well consistently with ETFs.
Holding an ETF for longer than a year may get you a more favorable capital gains tax rate when you sell your investment.
Every quarter or every 6 months when you receive your dividend payment, just log into your broker account and sell off a small number of shares in your ETFs to access extra cash. That is the right time to sell your ETFs.
