ETF Tax Loss Harvesting: How to Use the ETF Central Comparison Tool

Tax loss harvesting: a recap

When you sell an investment in a non-tax-advantaged account (like regular brokerage accounts, not tax-sheltered accounts such as Roth IRAs or 401(k)s) at a price higher than what you paid, you are liable for capital gains tax.

This tax has two rates: if you've held the investment for at least a year and a day, it's taxed at the long-term capital gains rate, which could be 0%, 15%, or 20% depending on your income. If held for less than a year, gains are taxed at your ordinary income rate, which can be as high as 37%.

Conversely, selling an investment at a loss allows you to claim a capital loss, which can offset capital gains. Here's how it works: short-term losses (on investments held for less than a year) offset short-term gains first, and long-term losses (on investments held for more than a year) offset long-term gains. If your losses exceed your gains, you can use up to $3,000 of the excess to reduce other kinds of income.

However, there's a crucial rule to follow to ensure you can legally claim this loss: the wash-sale rule. This IRS regulation prohibits you from claiming a loss on a sale if you buy a "substantially identical" security within 30 days before or after the sale.

The IRS hasn't clearly defined what "substantially identical" means, which creates a grey area. It generally suggests you avoid buying the same or a very similar stock or ETF. If unsure, it's wise to consult a tax professional to navigate these nuances effectively.

How to use the ETF Central comparison tool

Suppose we're back in 2022's bear market. You're holding the popular Vanguard Total Stock Market ETF (VTI) and you're considering some tax-loss harvesting. Here's how to use the ETF Central comparison tool to find a potential tax-loss harvesting partner:

1. Visit ETF's Page: Navigate to VTI's page on ETF Central. At the top, you'll notice a banner labeled "This fund is part of US ALL CAP," indicating its market segment. Clicking this link will show you VTI's peers, setting the stage for finding a suitable tax-loss harvesting partner.

1. Check 'Movers' Section: Start with the 'movers' section which highlights ETFs that have performed the best or worst and those with significant inflows or outflows over the week. This variety helps identify viable partners since investor sentiment in these funds tends to align.

1. Select a Partner: For this example, let's consider the Schwab U.S. Broad Market ETF (SCHB). To compare them, click the "Compare ETFs" link to put VTI and SCHB head-to-head.

1. Analyze Key Data:

• Characteristics: Examine the benchmarks each ETF tracks. VTI follows the CRSP U.S. Total Market Index, whereas SCHB tracks the Dow Jones U.S. Broad Stock Market Index. This difference suggests they are likely not "substantially identical," important for meeting IRS guidelines against wash-sales.

• Underlying exposures: Ensure both ETFs have similar sector allocations and share several top holdings. This similarity means that even though you're harvesting losses, you're maintaining a comparable market exposure.

• Performance and Volatility: Finally, review their historical performance and volatility to confirm if they behave similarly in various market conditions. This similarity further supports their use as tax-loss harvesting partners.

By carefully following these steps, you can potentially use SCHB to replace VTI in your portfolio temporarily, managing your tax situation effectively without deviating from your investment strategy.

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.