Tax Loss Harvest Questions. IWM vs VTWO

[Retireby45ish]

I have two questions. I googled the first and couldn’t find an answer. And figured I might as well ask the second

1. I wanted to tax loss harvest some IWM I bought last year. Is VTWO significantly different enough where I can buy this in its place? I know this is a bit grey but they both have almost the same description so I wanted to be safe to ask others’ thoughts.

Also, my plan, if these two were in a pretty similar place in 31+ days was to swap them back out since I prefer IWM since I can trade options (more liquidity) on that one. If they are both up then so be it I guess…

Edit: this link has me think these are too similar since they use these as the example. :facepalm

https://investorjunkie.com/investing/wash-sale-rule/

2. I would be locking in a short term loss with this. Is this better than a long term loss? For this question let’s assume I have both long term and short term gains this year as well. I think locking in the short term loss to offset the short gains is better. But again, I always want to be safe with this stuff and ask.

 

[Phroig]

IWM and VTWO track the same index, so they are “substantially identical”. The exchange is a wash sale. Second, yes, you want a short-term loss to offset the short-term gain, which will be taxed at a higher rate.

 

[Montecfo]

IWM and VTWO are similar, but I'm not sure they are "substantially identical".

Different fund companies, different managers, different expense ratios, a different number of security holdings and meaningfully different yields and different long-term performance. This tells me they are using different strategies to track the Russell 2000.

So I would conclude they are not substantially identical. But it's a facts and circumstances test, so hard to say if a revenue agent might see it differently in the unlikely event of an audit. I'm not aware of any authoritative guidance that directly addresses your specific fact set.

But if you wish to stay in small caps there are many other options to look at that would be less similar. I hold VBR and VBK, Vanguard value and growth ETFs which track different indices have different expense ratios than the ones you named, etc. Not sure they are right for you can hold them in complementary ratios and there is little doubt they would pass IRS muster. Research these using Morningstar. Lots of free highly useful data there.

On the second question, yes, short-term loss is better.

Good luck.

 

[MichaelB]

My first reaction was yes, they are similar. A web search brought this link from Fidelity https://www.fidelity.com/learning-center/investment-products/etf/tax-rules-for-losses-etfs

The tax law does not define substantially identical security, but it’s clear that buying and selling the same security meets the definition. For example, if you sell shares in the XYZ ETF at a loss and buy it back within the wash sale period, you cannot take the loss now. There has been no IRS ruling on whether ETFs from two different companies that track the same index are considered substantially identical.

If the IRS has not ruled in this, there is no definitive answer.

 

[Phroig]

"Substantially identical" doesn't mean identical. See https://www.kitces.com/blog/the-was...ubstantially-identical-mutual-funds-and-etfs/. All of this only matters if you get audited, and if that happens, you don't want to have to convince the IRS agent that one U.S small cap ETF is not substantially identical to another, especially if they track the same index.