Week in Insights: Wash Sale Rule Loophole Exposes Lack of Clarity

An analysis of trading data from earlier this year suggests investors may be using exchange-traded funds to avoid the wash sale rule, which bars investors from claiming losses after selling a security if they buy a similar security 30 days before or after the sale. While ETF swaps might seem like a clever short-term loophole, they inhabit a legal gray area that could invite scrutiny and enforcement actions.

ETFs are increasingly popular investment vehicles whose ability to diversify a portfolio has made them attractive to retail investors. In addition to their tax advantages, they’re also experiencing market gains—96% of ETFs have had positive returns in the past year.

The wash sale rule prevents investors from gaming the tax code by ensuring losses claimed for tax purposes reflect genuine economic losses rather than tax maneuvers intended to offset gains. Some traders may be sidestepping the wash sale rule by swapping one ETF for another that is nearly identical and realizing the loss for tax purposes.

For instance, an investor might sell a fund that tracks the Nasdaq-100 at a loss and immediately buy another Nasdaq-100 ETF. This would allow them to maintain the same economic position in the underlying assets tracked by the fund and harvest the loss without altering their actual investment.

The July analysis estimates that since 2001, tax-sensitive institutional investors have swapped more than $400 billion between highly correlated ETFs—resulting in billions of tax losses harvested annually. Because the wash sale rule proscribes selling an asset to harvest a loss and immediately repurchasing it—or a “substantially identical” asset—this strategy is legally questionable, as substantially identical hasn’t been defined for ETF purposes.

For investors, the takeaway from this revelation is a need for clarity. For regulators, the scale of the problem suggests a need for clearer guidance on what substantially identical means for ETF purposes. Market certainty and substantial tax revenue hang in the balance.

—Andrew Leahey

Welcome to the Week in Insights for Bloomberg Tax’s latest analysis and news commentary. This week, experts examined documentation of partnership loans, carbon taxes’ impact on developing countries, and more.

The Exchange—It’s where great ideas on tax and accounting intersect.

—Curated by Daniel Xu

Insights

Plante Moran’s Brett Bissonette uses a case study to show consequences for partnerships that fail to maintain proper documentation.

KPMG’s Chris Morgan explains issues and challenges on carbon tax fairness, saying that poorer countries may face higher energy, food, and transportation costs.

Ignacio Gepp of Puente Sur examines challenges created by a new Chilean law on the role of digital platforms, which face an increased tax reporting and administration burden.

Fireblocks’ Jason Allegrante says ending lawfare, clarifying rules, and ensuring equal access to financial services should be the US government’s top priorities regarding digital assets.

Perkins Coie’s Christopher Wilkinson, Elizabeth Holland, and Kaneem Thornton say employers should prioritize risk management and work with counsel to reduce bias-related risks of using AI tools.

News Roundup

GOP Plans Roadmap for Renewing 2017 Tax Law in First 100 Days

Republicans plan to leverage their sweep of the White House and Congress in the November elections to unilaterally move sweeping tax legislation, promising to push through renewal of the 2017 GOP tax law in the first 100 days of power. Read More

Illinois Ruling on Fuel Tax Allays Gas Industry’s Worst Fears

The Illinois Supreme Court recently handed Marathon Petroleum Co. a narrow win, relieving the oil and gas industry’s concerns of an explicit ruling that cash-only transactions are subject to fuel taxes. Read More

Trump Win Raises Pressure on Countries to Rethink Digital Taxes

President-elect Donald Trump’s victory has dialed up the pressure on countries to alter their taxes on US tech firms or risk retaliation. Read More

San Francisco Overhauls Business Taxes to Lure Large Companies

San Francisco is preparing a welcome mat to reward tech giants that weathered the Covid-19 storm and lure new companies with a simpler tax system that benefits the city’s largest and smallest companies. Read More

Career Moves

Lauren Meyers, Brent Schoradt, and Curt Wimberly were promoted to counsel at Vinson & Elkins.

Lauren Rubin joined Akin Gump Strauss Hauer & Feld as senior counsel in its lobbying and public policy practice in Washington.

Kevin Leftwich joined Jones Walker as a partner in its corporate practice group in New Orleans.

Jean-Dominique Morelli joined Herbert Smith Freehills as partner in its corporate practice in Luxembourg.

Narissa Lyngen was promoted to counsel at White & Case in its tax practice in New York.

Damien Bourke joined Dentons as a partner in its tax practice in Brisbane, Australia.

If you’re changing jobs or being promoted, send your submission to TaxMoves@bloombergindustry.com for consideration.