Funds as 'Placeholders' in Tax-Loss Sales

There are two important caveats to this. First, none of these workarounds are perfect or anywhere near. If they were, the IRS wouldn't allow you to claim the tax loss. However, they should do something to minimize the danger of getting embarrassed by a sudden sector rally the instant you take your tax loss.

Second: The IRS rules, as usual, aren't completely clear. But when it comes to using sector funds, finance professors and tax experts A. Seddik Meziani and James G. S. Yang suggest the advantage is on your side. They wrote a paper on precisely this subject in the monthly Practical Tax Strategies last year. And they suggest sector funds should avoid the IRS bar on "substantially identical" investments. "Sector ETFs are currently not recognized by the IRS as identical to the stocks that comprise their holdings," they wrote.

They note the IRS has already cleared people to park tax losses in other vehicles that would seem to be a lot closer to the original investment than a sector fund -- like bonds from the same issuer but of a different duration, or preferred and common stock from the same company.

The one risk they raise: There is a chance you could lose the tax benefit for that percentage of the sector fund which is specifically invested in the stock you just sold. So if you sell eBay and put the money in the Internet HOLDRS fund, which has 29% of its money in eBay stock, there is a possibility the IRS might argue that you "kept" 29% of your stock.

But even this isn't clear, Meziani and Yang argue. They also note that even if the IRS does eventually take that position, it might not be applied retroactively. As always in these matters, you should consult your tax adviser. As the IRS will tell you, only two things in life are certain.