originally posted at ETFTrends:
Many financial advisors use low-cost, liquid exchange traded funds in tax-loss harvesting strategies that can offset future gains and cut clients’ tax bills in the long term.

Talking about underwater positions is never fun as the end of the year approaches but realizing losses has a “silver lining,” said Rande Spiegelman, vice president of financial planning at the Schwab Center for Financial Research, in a conference call with reporters Friday.

“The good news is losses can be used to lessen the tax bill and position for next year,” he said.

Realized losses can be deducted from ordinary income by up to $3,000 a year, while any additional losses can be used in future years.

However, investors need to be aware of the “wash-sale” rule. Investors cannot claim the loss if they buy a “substantially identical” security within 30 days of the sale.

This is where ETFs can help out if investors want to keep exposure to the market.

For example, an investor may be sitting on a loss this year on a financial stock, explained Michael Iachini, managing director of ETF Research at Charles Schwab Investment Advisory. The investor can sell the stock and take the loss, but they might miss any rebound rally in the financial sector over the next month.

To maintain exposure to the sector, the investor could buy an ETF indexed to financial or bank stocks, Iachini said on Friday’s call. ETFs are a “good fit” for the strategy if investors don’t want to be out of the market for a month.

Some financial advisors use tax-loss harvesting strategies featuring ETFs that track the same sector but are pegged to different indexes.

The IRS hasn’t provided a hard definition of “substantially identical,” and investors should consult a tax advisor about the wash-sale rule.

Also, investors need to consider any ETF commissions or other trading costs associated with the strategy.

Finally, Schwab’s Spiegelman said not to lose sight of the overall investment plan and let the “tax tail” wag the dog. “Don’t upset the long-term investment plan or asset allocation just to get a tax break,” he said.

“ETFs have made tax loss harvesting a lot simpler than it used to be,” said Charles Zhang of Zhang Financial in a recent Reuters report. “It’s not that hard to find one that’s a good stand-in.”

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