Dave writes:
I’ve been reading and enjoying your tax tips blog.

I have a question about wash sale and mutual funds/etfs.

I just sold shares of Vanguard’s VPACX mutual fund (based on the MSCI Pacific Index) at a loss. To avoid wash sale rules and keep my capital loss, what am I allowed to buy within 30 days? Can I buy shares of VPL, Vanguard’s Pacific ETF which based on the same index as VPACX (and is actually a different share class of the same fund)? If not, what about the ADRA ETF, which is based on the Bank of New York’s Asia 50 ADR Index? The latter has significant overlap in holdings with VPL/VPACX, but has different allocation and some different positions.

Thanks,

David

My reply:

Hello David!  Thanks for your kind words about my blog.

You asked a very good question.

As I’m sure you’re aware if you sell a security at a loss your tax loss is disallowed if at some point during the 30 days before you sold the security or 30 days after you sold the security you purchased “substantially identical” securities.  These same rules apply to loss from sales of mutual fund shares. In fact, if you are automatically reinvesting your dividends, wash sales can become common.  Any disallowed loss due to the wash sale rule is added to the basis of the replacement shares purchased within the forbidden 61-day period.

Stocks issued by one corporation are not considered substantially identical to stocks issued by another corporation; however mutual funds aren’t as clear cut.  With mutual funds the IRS has taken the position that each transaction needs to be evaluated separately; thus they have not issued any clear guidelines as to what they will ultimately consider “substantially identical” and what they will not.  In other words, this is something that you’re going to have to make a decision on and document your reasoning in your personal tax records, just in case the IRS were to ever question it.

Some people take the view that no mutual fund is “substantially identical” to another, but I don’t agree.  It’s my belief that the wash sale rule is based on your position in the market.  Thus, in my opinion, two different mutual funds or ETFs that are based off of the same index and/or hold substantially the same securities would be considered “substantially identical” and be subject to the wash sale rules.

I hope this helps you make your decision.

Best wishes,
Gina