ETFs Hold Wash-Sale Rule Advantage
"Tax-selling tends to peak in mid-November and mid-December, often producing mild dips at those times," says Phil Roth, technical analyst at Miller Tabak. "People that are intellectually preparing for the year-end tend to do the bulk of their tax-selling in November, so they have the opportunity to repurchase before the end of the year and avoid the wash-sale rule."
Here are two strategies using ETFs for investors who are resolute and smart enough to do their tax planning year-round -- although you should always check with your tax adviser before making any moves:
Strategy 1: Taking Individual Stock Losses While Maintaining Sector Exposure
In this case, let's use a real, but somewhat arbitrary, example. Let's say you are holding too large a position in Wal-Mart (WMT) and your portfolio is dangerously out of balance. Furthermore, the Wal-Mart shares you purchased happen to be trading below your purchase prices. Because Wal-Mart accounts for more than 11% of the Consumer Staples Select SPDR (XLP), an ETF that contains the 37 consumer staples listed in the S&P 500, you can: (1) sell your Wal-Mart stock; (2) claim the loss on your tax return; and (3) buy the Wal-Mart-heavy ETF to maintain your exposure to Wal-Mart and to that sector in general.
And after 30 days, you can choose to buy back some or all of your Wal-Mart position and sell the ETF.Dan Dolan, an ETF specialist, says investors also can use this strategy to take a loss in a mutual or closed-end fund while maintaining exposure to a particular sector. For example, if you are holding a technology fund that is currently under water from where you purchased it, you can sell the fund, realize the loss and buy a tech ETF like the Technology Select SPDR (XLK) to stay exposed to the sector.
Strategy 2: Swapping One ETF for AnotherPaul Mazzilli, an ETF strategist at Morgan Stanley, says investors also can swap sector ETFs "if they have similar -- but not exactly the same --- holdings, and are based on different indexes." Again, let's use actual securities for a hypothetical example. This means that investors staring at unrealized losses in iShares Dow Jones US Healthcare ETF (IYH) can switch into the Vanguard Healthcare VIPER (VHT) or the Healthcare Select SPDR (XLV) for 30 days and still comply with the wash-sale rule. Mazzilli says the swap is kosher under the wash-sale rule because each ETF corresponds to a different index. The Dow Jones Healthcare ETF tracks the performance of the Dow Jones U.S. Healthcare Sector Index; the Vanguard ETF follows the MSCI U.S. Investable Market Health Care Index; and the Select Spider tracks the health care components of the S&P 500. To view Gregg Greenberg's video version of this report, click here.
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