Swapping That ETF Might Not Trigger a Tax Hit

Hi Beverly,

Tracy Byrnes, (one of your predecessors at the TSC Tax Center, then known as TSC Tax Forum), in an article dated 1/8/00 titled Special Edition -- Tax Rules for Exchange-Traded Securities wrote:

"Tricky Wash Sale Rule -- selling one exchange-traded index security at a loss and buying another within 30 days will NOT trigger the wash sale rule" (emphasis added).

My question: Is this still true? If so, do you know the rationale for this exception to the wash sale rule requirement?

Thank you very much,

Bob Gillespie

Bob,

Selling one exchange-traded fund at a loss and buying another exchange-traded fund within 31 days will not trigger the wash sale rule -- provided they're different exchange-traded funds. Selling 100 shares of the QQQ (which tracks the Nasdaq 100 index) at a loss and then repurchasing another 100 shares of the QQQ within 30 days will trigger the wash sale rule -- meaning the loss would be disallowed. (You can adjust the basis in the new shares to reflect the loss, though, effectively letting you claim it when you sell the replacement batch.)

You can, however, claim a loss on the sale of Vanguard's Extended Market Vipers, which tracks the Wilshire 4500, and repurchase the same number of shares in Vanguard's Total Stock Market Vipers, which tracks the Wilshire 5000, without violating the wash sale rule.

As to your second question: It's not so much a "rationale" as it is a lack of formal opinion on the part of the Internal Revenue Service. The wash sale rule disallows the loss when "substantially identical" securities are purchased within 31 days of when the loss was incurred. (That means you can't buy new shares 30 days before you sell the stock, either.) Since the IRS has never issued a concrete definition of "substantially identical," many tax planners argue that selling a Vanguard S&P 500 index fund at a loss and purchasing a Fidelity S&P 500 index fund within 31 days will not violate the wash sale rule. And until the IRS rules otherwise, they're right.

The nature of how ETFs are created precludes them from holding truly identical underlying securities, so there's even less reason to fear the wash sale rule -- again, as long as you don't buy the same exact ETF.