I have written many times before about tax-loss harvesting. Tax-loss harvesting is when you sell a security in a taxable/non-qualified/brokerage account at a loss and immediately buy something very similar to it but not, in the words of the IRS, “substantially identical” to it. Up to $3,000 a year of those losses can be deducted from your ordinary income and unlimited amounts can be used to offset both short and long-term capital gains from fund distributions and selling appreciated shares.
If you combine tax-loss harvesting with the step-up in basis at death and/or the contribution of appreciated shares to charity, it can be a very powerful technique that allows you to invest VERY tax-efficiently in a taxable account. You can also give appreciated shares to someone in a lower tax bracket and let them sell them, just beware of the federal and state estate/gift tax exemptions (up to $15K per person per year doesn't count toward the $11.4M exemption on the federal side, but some states have much lower limits).
Don't Reinvest Dividends in Taxable
The Wash Sale
However, sometimes people get so excited about tax-loss harvesting that they start doing it very rapidly and run into some problems.
The most common problem is doing a “wash sale.” This occurs when you buy an investment within 30 days before or after the time you sell it. While you are allowed to do that, doing so is a “wash sale” and you cannot now claim that loss on your taxes. The brokerage firms like Vanguard, Fidelity, Schwab, and eTrade are very good at keeping track of this stuff so long as you are doing all of your buying and selling at their brokerage/mutual fund firm. If you have multiple accounts at multiple firms, they won't be able to help you and you'll need to keep track of it yourself–the rules still apply.
In fact, the rules even apply if you sell one fund in your taxable account and buy it within 30 days before or after the sale in your IRA. Some have even speculated that this “IRA Rule” applies to your 401(k)s. It seems likely to definitely apply to your individual 401(k), but whether it applies to an employer's 401(k) is a little less clear. The most conservative avoid it, while the more cavalier are well aware that neither IRAs nor 401(k)s actually report your specific investments to the IRS and spend much less time worrying about this issue.
So the biggest thing to worry about with regards to the wash sale rules is selling and buying and selling and buying too fast. For example, if you exchange from the Vanguard Total Stock Market Fund to the Vanguard 500 Index Fund (not substantially identical but still with a 0.99 correlation) and then back to the Total Stock Market Fund two weeks later, you've done a wash sale. Likewise, if you buy the Total Stock Market Fund two weeks before exchanging some other shares of the fund to the 500 index fund (although note if you also sell the TSM shares you just bought, that is not a wash sale). This is a good reason not to put a taxable investing program on autopilot with frequent purchases. Less frequent, larger purchases are much easier to keep track of for tax-loss harvesting purposes.
That's exactly what burns people when it comes to reinvesting dividends. While I reinvest all my dividends in IRAs and 401(k)s, I do not do so in a taxable account. It creates lots of tiny tax lots that can be complex to keep track of (although the brokerages do a nice job), but most importantly, it means I'm buying a fund as frequently as every month, making it very tricky to avoid wash sale rules. So my general advice is don't reinvest your dividends in taxable in any investment with potential to appreciate (obviously it's fine in a fund where all returns are paid out regularly such as a money market fund or hard money loan fund.)
Beware the 60-Day Qualified Dividend Rule
Most people who have been tax-loss harvesting for a while know all about the wash sale rules (and have likely violated them once or twice.) What they may not be aware of, however, is the 60-day rule for qualified dividends. Stock dividends (including those distributed through a mutual fund) are either qualified with the IRS or non-qualified (like bond dividends.) The idea behind qualifying some dividends and not others is to encourage long-term investment. So one of the qualified dividend rules is that you must hold the investment for at least 60 days around the ex-div date (i.e. when the dividend is paid). So perhaps 45 days before the ex-div and 15 days after. Or 10 days before and 50 days after. If you don't hold the stock or fund that long, the dividend is NOT qualified, meaning you'll pay taxes on it at your higher ordinary income tax rate instead of the lower qualified dividend rate. That could mean paying up to 20% more in taxes on those gains.
So the bottom line is don't get into the habit of frenetically harvesting losses. Not only are you more likely to end up with a wash sale, but you may turn dividends that would otherwise be qualified into non-qualified dividends.
What do you think? Have you screwed up either the wash sale rule or the 60-day rule? What happened? How do you invest tax-efficiently in a taxable account? Comment below!
I’ll be the first to admit that the 60-day rule is barely on my radar when I tax loss harvest. Running the math, I see little reason for concern. There is a consequence to violating it, but it’s rather minimal.
An example.
Let’s say I purchased $20,000 of VTSAX earlier this month and now it’s down 10%, or $2,000. I exchange it for VFIAX, creating a $2,000 paper loss.
Next month, VFIAX pays a quarterly dividend of about 0.5% or $100.
But the market continues to drop, and in early April, my VFIAX is down 5% from when I purchased it, so I decide to TLH again by exchanging it back to VTSAX, harvesting an additional $1,000 in paper losses. It’s been more than 30 days, so no wash sale issues, but less than 60 days, so my $100 dividend that was paid out in late March will be taxed at ordinary rates rather than the qualified dividend (long-term capital gains rates).
Let’s say I’m in the 32% federal income tax bracket and my state / local income tax is 5%.
Tax loss harvesting saves me 37% on the first $3,000 harvested (and further losses harvested may save me even more in the future if tax rates increase or my marginal bracket is higher. So I saved $740 on the first $2,000 harvested and $370 when I went back to my original position in VTSAX in April, for a total of $1,110 in tax savings.
Let’s look at the taxes on the dividend. If I had held VFIAX for more than 60 days, I would owe 15% + 3.8% NIIT + 5% state income tax for a total of 23.8%. On $100, that’s $23.80.
By holding for 31 to 59 days, I turned what would have been a qualified dividend into an ordinary, non-qualified one. I owe 37% of $100 or $37 on it.
The difference is $13.20.
It’s such a small percentage of the benefit you get from tax loss harvesting that it’s essentially inconsequential.
Now, if you’re harvesting a $50 loss on an asset held between 30 and 60 days, it’s a different story, but even then, you might want to do it to get back to your original position.
Thank you for forcing me to run the numbers.
Cheers!
-PoF
The way this comes into effect is not when you have $20,000. Let’s say you have $500,000. It drops 1% and you decide to tax loss harvest the $5K loss. So far, so good. But what if you just turned your next dividend from qualified to non-qualified. The dividend is $2500. The difference between LTCG at 20% and your marginal tax rate at 37% is 17%. So 17%*$2500 = $425. Now is that less than the 37 %* $3000 = $1,100 you saved on your taxes this year from tax loss harvesting? Sure. But what if you already had $30K in losses saved up and that additional TLHing didn’t help at all. Now you just paid $425 in taxes that you didn’t need to pay with no offsetting benefit, at least for a few years. Plus, for many people TLHing is just deferring taxes. You’re saving $1,100 now but when you sell you’ll owe 20%*$3000 = $600. $600 + $425 is barely less than $1,1000, not counting the time value of money.
After yesterday, I now have six figures in losses saved up. Who knows when/if I’ll EVER be able to use them up, especially if this keeps going. So I really don’t want to pay extra dividend taxes to get more, thus the need to wait 60 days now before doing it again with those same shares I sold yesterday.
That makes sense. The larger the lot and the lower the percentage loss, the more the 60-day rule matters.
It’s also true that if you realize the gains later on, the benefits of TLH are mitigated. It’s most beneficial for those who donate appreciated assets or plan to pass them on to heirs with a stepped up cost basis (if that rule survives as long as we do).
Cheers!
-PoF
Agree and disagree about TLH. What you’ve said is true but for the long term investor it’s not just about dying or donating but instead realizing gains far off in the future at a lower capital gains rate or a zero rate (as the tax code stands) if you control your AGI. Plus, money now is more valuable than future money.
On dividend issues though I do tend to agree with the first comment though; in a lot of situations the benefits of TLH outweigh the costs of dividend taxes assuming low dividend market ETF’s. Even if you’ve already banked a lot of capital loss carryover’s, you’re extending the tax benefits long into the future and giving yourself more headroom for future spending/trips during (early or not) retirement.
Oh, definitely. The tax arbitrage between ordinary income tax on the $3,000 annually versus paying capital gains taxes later on (or perhaps not if you have room to tax gain harvest) is real. The benefit is mitigated, but not eliminated when you pay tax later.
But you may never pay taxes on capital gains at all, and that’s how you get the most bang for your buck.
Best,
-PoF
Really interesting conversation here. Adds to the post for sure. Jim, if someone collected a lot of rental income, could they offset those gains with capital losses from TLH?
Not the rental income, but the capital gains on the property.
Well, up to $3,000 a year can be used to offset ordinary income annually.
Yup I’ve been caught by this. Sold some mutual fund shares in, say, November and then when the automatic reinvestment bought more shares with the dividends in December it occurred. I didn’t know until I did my taxes and grumbled about the 1099-DIV from Vanguard reporting that I had short term taxable income (guess it wasn’t the dividend- now THAT is REALLY complicated) or just from the capital gain payment mutual funds often kick out in December. That was another factor in the decision, now we’re semiretired, to NOT reinvest dividends anymore. We still end up doing so; but on purpose; and not automatically, from the fund the dividends sweep in to. And I guess I shouldn’t do so in January/ February if a fund has kicked out end of year gains! (Too late, I just did.)
Have to note that this is one thing (granted, a small irksome at tax time issue not a huge money loss for us) I wish you had written about in a way I could comprehend a few years back (most of the things I learn from you I already sort of knew, and I just presume the many things I don’t easily grasp probably don’t apply to us- ignorance being bliss). And I certainly hope, when I start tapping our TSP and IRAs etc, that I don’t have to fool with taxes on wash sales I’m not even tracking. If I pay regular rate on everything coming out I’m not asking for lower long term rates anyway, IRS! But if anyone convinces you that actually is the case let us know so younger folk (and maybe even me for a few years) can start purposely managing retirement funds to prevent that.
Timely post given the recent market volatility. I haven’t yet TLH given only recently started a taxable account. Two questions come to mind:
1) Do most people keep mutual funds or ETF in their taxable accounts (VTSAX or VTI for instance). I generally prefer mutual funds as it’s easier overall but it may be harder to capture losses in a taxable account if you don’t know where the market will end on a particular day.
2) Given the potential wash sale rule with IRAs at same brokerage house, how do people handle it when you have a particular investment in both the your taxable account and the IRA. For instance, my asset allocation calls for a certain amount of VTSAX across my entire portfolio – hence I have it in my Roth but then it is currently also my only holding in taxable. I want to turn off automatic dividend reinvestment in the taxable account as this article indicates but that doesn’t help me if small tax lots are automatically purchased in the Roth account. Do you recommend turning off automatic dividend reinvestments in the Roth account as well or some other solution. Hopefully my accounts will grow enough where I will have entirely different funds between taxable and Roth/401k accounts, but as of now the portfolio just isn’t large enough and I do have some repeat holdings across the various “buckets.”
Thanks
1. Varies. I have both. With Vanguard doesn’t matter much. With another company, go with ETFs. Yesterday I put the orders in early in the morning to exchange funds and ended up with a much bigger loss than I expected.
2. The IRS doesn’t know what you have in your IRA or 401(k). Most people don’t understand this rule. Heck, most people don’t tax loss harvest. So you’re supposed to keep track of all this. Right now you haven’t had a dividend in 2 months so if you just turn them off in your IRA for next month’s dividend,(and any automatic purchases coming up) you can tax loss harvest now with impunity. Obviously TLHing isn’t for those who want everything on autopilot going into target retirement funds. It requires some interest and effort but does drop your tax bill a bit.
So, I’m kind of confused about the 30 day before or after purchase rule. My situation is I auto-draft from my paycheck into my Vanguard Taxable account on a monthly basis and purchase VTSAX, so I have many individual tax lots. My last purchase was on 2/16. Assuming I also TLH the last lot of VTSAX I bought into a S&P fund, would this constitute a wash sale? Or would I have to sell all of my previous lots to prevent the wash sale?
No. But if you didn’t sell that lot and sold a previous one, it would be a wash sale.
Jim,
Are you now running your own White Coat Insurance Group out of Florida? Got their email to my work email about disability etc.
No. My attorney has asked me not to say more for now. But thank you for letting me know.
Great article. Always seem to pick up something new from your articles. Question somewhat related to TLH. Since you can only use a loss of $3k per year, if you have a loss of $10k can you exchange $7000 of stock profits so you don’t have to pay for those gains later? While the math works, doesn’t seem like that is something that the government would be okay with. Forgive my ignorance on this.
You could, but I wouldn’t bother doing anything right now because you carry the losses forward until whenever you acquire gains.
Question re: Tax Loss Harvesting between 3 different funds. Say you harvest losses from Fund #1 into Fund #2. The market continues to drop, so 1 week later, you exchange everything from Fund #2 into Fund #3. And now the market drops again 1 week later. Can you exchange Fund #3 back into Fund #2, or is Fund #2 quarantined for 30 days since the last transaction, so you are kind of stuck with Fund #3?
Stuck in fund 3. But you can find fund 4 or just wait 3 more weeks and go back to 1 or 3 more weeks and go back to 2. Honestly though….if you’re going through more than 3 funds in 30 days, you’re probably going to run into the 60 day rule. Slow your roll.
For international TLH partners, IXUS (for VXUS) goes Ex-D only twice per year instead of quarterly.
If my 403b/457 has target date funds and my taxable account has VTSAX can I tax loss harvest? Or because the target date fund contains 50% vanguard total stock market funds and I am passively sending 10% into that fund every 2 weeks, TLH just isn’t an option for me?
You’re totally fine.
The target date funds are not remotely substantially identical to VTSAX even if they contain VTSAX as one component of the fund.
Furthermore, the IRS has not definitively said whether or not a wash sale can result from a purchase in workplace retirement accounts. It’s considered by most to be a gray area, but no one seems to be aware of a wash sale having been created by a purchase in an account such as a 401(k), 403(b), or 457(b).
Best,
-PoF
It’s fine. Not substantially identical. Not even close.
Thank you for the reminder on this! It happened to me in 2018 when I enthusiastically did my first TLH. And come tax-time in 2019, couldn’t for the life of me figure out why I had so much in non-qualified dividends despite having a good little Boglehead portfolio. It may have negated out a significant amount of the tax benefit of the TLH for me- because, as Jim pointed out above, if the lots are big, it does add up (I TLH’ed TISM, so it was a chunk of change).
Does the 60-day rule matter if you bounce around between two dividend distributions? I just sold from Fund 1 at a loss into Fund 2. If the market keeps dropping, I will exchange from Fund 2 (and older shares from Fund 1 that have turned into losses since the previous drop) into Fund 3. As long as I am out of Fund 2 before it issues a dividend and stay in Fund 3 for the 60 day window, am I in the clear? If so, I suppose you could do this multiple times without violating the rule as long as you stay in the fund that issues the dividend for 60 days.
Yes.
Let’s say I bought VTSAX on 2/24 and want to TLH 30 days from then. The record date for the VTSAX dividend is 3/24/20. Do I need to sell beyond 60 days of this date to avoid violating the 60-day rule for the lot purchased on 2/24 only, or on ALL prior lots of VTSAX as well. For example, can I sell VTSAX lots on 3/31 from last year and be ok?
I definitely made this mistake this month. How can I easily check when the dividend dates are going to be? Where is this info posted?
There might not be one, but for TSM it’s usually between the 23rd and the 29th of the month. I think Vanguard usually publishes it in advance, but I don’t know how far in advance.
Thank you! My IPS said to TLH if >1k loss which led to some frenetic TLH. How can I revise my IPS to be more reasonable? Add in a clause about checking for dividends? Change to >5k loss? Thanks again for all you do!
Delete that paragraph? 🙂
I dunno. Just keep the rules in mind and don’t break them.
With a little extra time on my hands right now I am finally getting around to understanding TLH. I have also read your step-by-step guide and primer articles – both great. While I understand the nuts and bolts for the most part, I am still a little confused on how to handle selling some of my shares while avoiding the wash sale rule. Before reading these articles I had bought more shares of VTSAX about 2 weeks ago. I also had a dividend from VTIAX paid out and reinvested last week. I just updated my taxable earlier this week to not automatically reinvest dividends and capital gains in the future but rather pay them to my settlement fund. So, my question here, can/should I TLH the shares I’ve held for >30 days now or do I need to wait 30 days from the buy and divided payout dates to avoid the wash sale?
As long as you include the lots that you bought in the last 30 days, there won’t be a wash sale. The portion of the dividend attributed to the recent purchase of VTSAX won’t be qualified though unless you wait 6 weeks.
I have a question regarding a taxable account and dividends. I plan on investing in a taxable account beginning January in an index fund (Not ETF). I do not plan on buying and selling, just buying and holding for the long-term. Will it be problematic to have my capital gains/dividends automatically reinvested as I will not be selling? My understanding is that as long as I hold the investment for longer than a year, I pay long term capital gains on my dividends. I don’t see the downside.
You pay dividend rates on qualified dividends and capital gains rates on capital gains. Qualified dividend rates and long term capital gains rates are lower than ordinary income rates. You must hold it t least a year to get long term capital gains rates. You must hold it at least 60 days around the time of the dividend to get qualified dividend rates. One downside to reinvesting dividends in taxable is it can cause wash sales when you tax loss harvest.
Ah ok. That makes sense. I appreciate your response!
If I sell a Cal. Intermediate Term Vanguard Muni bond fund at a loss and buy a CA Long (within 30 days), are these dissimilar enough to avoid the wash rule? How about switching to a CA Muni MMF?
Thanks
Yes. Yes.
Suppose I have substantial capital losses carried over from previous years. Also suppose I have a 1000 shares in a company trading around $50/share and they announced a special dividend of lets say $3 per share. Also suppose that I purchased said stock 6 months ago at $40/share, thus I currently have $10 in unrealized gains for the stock. Suppose the stock is still trading at $50 the day before the dividend ex date. Wouldn’t it be better for me to sell the stock and realize the $10/share gain the day before the dividend ex date so that I do not receive the dividend? The day after the ex date the stock price will be lowered by the amount of the $3 dividend to $47/share. I can then buy it back at $47 per share. The wash rule wouldn’t apply since I didn’t sell the stock at a loss. Furthermore, I wouldn’t receive the $3000 in dividends thus not be taxed on it. The $10,000 in capital gains would be offset by the substantial losses I already have from prior years. By selling at $50 and buying back at $47 I will, in essence, have received the dividend without it being taxed. Wouldn’t this be the better option for someone who has losses carried over from prior years?
Yes. Cool strategy. Not sure if it is worth the risk of being out of the market but it’s an interesting way to use up some of those capital losses to save even more.
Late to the party here. I want to be sure that I’m understanding the 60-day rule.
The ex-dividend date is one business day before a dividend is declared, correct? I must own the shares I’m selling for at least 61-days in order for that dividend be considered qualified, but the calendar for this doesn’t start until 60 days before the ex-dividend date. So, even if I’ve owned this fund more than 60 days before the ex-dividend date, I still need to wait at least one day more to sell in order for that dividend to be considered qualified. Is that correct?
From the IRS instructions for Form 1099-DIV (Rev. January 2022) Dividends and Distributions (the “diminished risk of loss” statement is also confusing–does this mean weekends and holidays when the market isn’t open?) :
Dividends the recipient received on any share of stock held for less than 61 days during the 121-day period that began 60 days before the ex-dividend date. [snip] When determining the number of days the recipient held the stock, you cannot count certain days during which the recipient’s risk of loss was diminished. The ex-dividend date is the first date following the declaration of a dividend on which the purchaser of a stock is not entitled to receive the next dividend payment. When counting the number of days the recipient held the stock, include the day the recipient disposed of the stock but not the day the recipient acquired it.
I don’t know that the ex-div date is always just one day before, but it’s announced by each fund/stock and is usually within 1-3 days before it is paid.
61 days total is the requirement. So I don’t know why you’d have to own yours another day after the dividend. If you want to sell, maybe even do it before the dividend is paid. Then you don’t get it at all and maybe you have some tax losses to offset the capital gains.
I think the “diminished risk of loss” days are between the ex-div date and the date the dividend is actually paid.
Thanks! Right, I checked and in this case the ex dividend and dividend paid dates are the same. I am going sell the lots of this fund that have losses, but it’s too late now to sell before the dividend was paid–that happened last week. Most of what was paid was capital gain though. This is a managed mutual fund that I’ve held in my taxable brokerage account for decades, unfortunately, and there would be sizeable gains to pay if I sold the whole thing now, but I will be chipping away at it (and others) over the next few years, and replacing them with more tax efficient investments.
I am confused about the wash sale rules as it relates to similar investments within a 401k
As an example, let’s say both my Taxable and 401k is through Vanguard as a single login. I invest in VTIAX in my taxable account and I invest in VTSNX in my 401k. These are essentially the same investments, but in a different class with one being in the 401k. If I tried to tax loss harvest VTIAX but automatically purchased VTSNX within those 30 days, would this create a wash sale? Guess I could always turn off the auto invest in my 401k until the 30 days have passed
The IRS hasn’t said. They have said doing that with an IRA is a wash sale, but they have never specified about a 401(k). So the most conservative thing to do is to not do it. The aggressive approach is to not worry about it since the IRS hasn’t said it’s a wash sale. Your choice. It’s a gray area, so it’s your call. I would be interested to hear if Vanguard treated it as a wash sale.
Tax loss harvesting and automatic investing don’t play well together and you’ve provided a good example of why.
Yeah, interestingly Vanguard doesn’t show the 401k account when I look for cost basis or dividends/capital gains, even though my Roth IRA shows up on these. I’ll let you know if this shows up as a wash sale
That is interesting. Obviously cost basis doesn’t matter with retirement accounts. But date of purchase in IRAs does.
I need some clarity re: 60 day qualified dividend rule. A hypothetical example:
I own $90k of Vanguard TSM, purchased 1/1/22.
I purchase an additional $10k of Vanguard TSM on 1/1/23.
Vanguard pays out a dividend on TSM on 1/7/23.
Price of TSM drops significantly on 1/13/23. I still have a potential gain for the lot purchased on 1/1/22. But I have a potential loss for lot purchased on 1/1/23.
On 1/14/23, I sell 100% of shares of TSM purchased on 1/1/23. I do not sell any shares purchased on 1/1/22.
Re: the dividend that is paid out on 1/7/23 – is it qualified, ordinary, or both (90% qualified and 10% ordinary)? I still own those shares purchased on 1/1/22 (owned for over 365 days). But those shares that were purchased on 1/1/23 were owned for less than 60 days.
Thanks for the help!
Ordinary for the 2nd lot. Qualified for the first lot.