Advisors should consider a familiar tool to save their wealthy clients on capital gains taxes.

Tax-loss harvesting is selling a security at a loss and using the deduction to offset capital gains incurred on another investment. The position sold is then replaced with a similar investment.

Exchange-traded funds can work well in this scenario as a liquid asset offering exposure to an investing niche or a good avenue for diversification. More to the point, ETFs are usually distinct from each other, which makes them ideal for tax-loss harvesting.

“The implementation through ETFs is relatively new, and it’s a smart way to stay associated with a similar sector and play by the tax rules,” said Pete Carmasino, director of Advisor Strategies at Chaikin Analytics in Philadelphia.

“The tax-sensitivity of [ETFs] is one of the primary reasons the ETF business is over $4 trillion in the U.S.,” said Robert Holderith, CEO and chief product engineer of Green Harvest Asset Management in New York City. “Although they’re aware of these benefits, [wealthy clients] are generally not aware of the strategies that can be implemented best and, in some cases only, with ETFs.”

“What makes ETFs preferable is that they tend to be easy to trade, have lower expense ratios and are tax-efficient,” said John Vento, a CPA/CFP in New York with Avantax Investment Services and Avantax Advisory Services and author of "Financial Independence (Getting to Point X)."

If you sell a security at a loss, you can’t repurchase an identical security for at least 30 days—a limitation known as "the wash sale rule." “This is one of the advantages of ETFs. You can replace your sale by buying a similar ETF, as long as it isn’t identical,” Vento said.

When the IRS says “substantially identical," it doesn't go into great detail, Carmasino added.

“If an investor sold one particular tech stock and invested in a tech sector ETF, those investments are not substantially identical. If an investor sold one S&P 500 index ETF and bought another S&P 500 index ETF, they would likely be considered substantially identical,” said Joe Bublé, a partner and tax practice leader at Citrin Cooperman in New York.

IRS Publication 550, “Investment Income and Expenses,” states, “Ordinarily, stocks or securities of one corporation are not considered substantially identical to stocks or securities in another corporation.” And the ETF of one fund company, compared to another fund company, usually differs in structure, expense ratios, returns, price per share and many other details, according to Craig Richards, managing director and director of tax services at Fiduciary Trust Company International in New York.

Green Harvest builds portfolios of low-cost, passive ETFs that provide risk and return attributes of the S&P 500 or other benchmark, purchasing market weights of each of the 11 S&P 500 sector ETFs. The firm then monitors for opportunities to capture tax benefits such as harvested losses. “When a target threshold is reached, we sell an ETF to capture an available loss and simultaneously repurchase a similar ETF,” Holderith said.

First « 1 2 » Next