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Okay-- as I understand it, it's a "wash sale" if I sell a security, and buy a "substantially identical" security within 30 days. My question is about the meaning of "substantially identical".

Suppose I just took a big loss on my shares of the Vanguard S&P 500 Index Fund (it could happen, if I buy at just the wrong time...) I want to stay invested, but realize the loss. So I sell all my shares of the Vanguard S&P 500 Index Fund, and I reinvest right away in the Schwab S&P 500 Index Fund. Is that a wash sale? The two mutual funds are invested the same way, and perform about the same, but are run by different companies.

Thanks,

--AMS
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<<Okay-- as I understand it, it's a "wash sale" if I sell a security, and buy a "substantially identical" security within 30 days. My question is about the meaning of "substantially identical".

Suppose I just took a big loss on my shares of the Vanguard S&P 500 Index Fund (it could happen, if I buy at just the wrong time...) I want to stay invested, but realize the loss. So I sell all my shares of the Vanguard S&P 500 Index Fund, and I reinvest right away in the Schwab S&P 500 Index Fund. Is that a wash sale? The two mutual funds are invested the same way, and perform about the same, but are run by different companies.>>

Interesting question; one we ponder from time to time. In a strict reading of the Internal Revenue Code and regulations, this would not be a wash sale. But the IRS has sometimes succeeded in applying the wash sale rule (or perhaps it would be more accurate to say a "common law" wash sale rule) in situations where it is clear that the Code and regulations do not apply. For example, in the Horne case, a broker was denied a loss deduction when he sold a stock exchange membership at a loss and bought another one. The wash sale rule couldn't possibly apply because he hadn't sold "stock or securities," but the IRS won anyway.

So, if you want to take this maneuver, you pays your nickel and you takes your chances. I'd say this is fairly low-risk (in part because of the Cottage Savings case), but not no-risk. You'd be safer (virtually bullet-proof) if you chose instead to "stay invested" by holding a broad large cap fund that was likely to perform similarly to the S&P but was not designed to mimic it exactly. Less tax risk but more market risk, perhaps. Your choice!

KAT in Chicagoland
www.fairmark.com
Tax Guide for Investors
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(I just posted this question on the Retirement Investing board, so I apologize for the duplication, but I thought it was appropriate here.)

If I sell shares of stock in a company that I hold outside of an IRA, and subsequently buy shares of the same stock within my IRA, is this considered a "wash sale"?

I want to fund my IRA this year, and don't have the cash at present, but do have securities that I would like to have inside of my IRA.
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<<If I sell shares of stock in a company that I hold outside of an IRA, and subsequently buy shares of the same stock within my IRA, is this considered a "wash sale"?>>

The answer is that no one can say for sure. The wash sale rule, as written in the Code and regulations, does not apply in this situation. But the IRS has sometimes contended -- successfully -- that a loss should be disallowed when a taxpayer sells property at a loss and uses a controlled entity to buy identical property. Some experts conclude that there is, in effect, a "common law" wash sale rule in addition to the one in the Code. There are no cases dealing with IRAs, so the issue is unclear.

The stakes are higher with this maneuver than with a regular wash sale. Normally if the wash sale rule applies you get an increase in the basis of the replacement stock, and later you can use that basis to recognize a loss or reduce a gain. But if the replacement stock is in an IRA, the increased basis does you no good, so the adverse results are more severe. That's why I shy away from recommending this course of action.

KAT in Chicagoland
www.fairmark.com
Tax Guide for Investors
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