Harvesting Gains with ETFs

Jeremy Glaser: Let's talk a little bit about trading tactics using ETFs to help manage your tax bill.

Scott Burns: Right. Normally I think the things people are most commonly familiar with with ETFs is harvesting tax losses and using ETFs to do that effect. If you had a loss in a manager or even another ETF, what you could do is sell the loss in the ETF and buy a similar fund. You can't sell probably the SPDR S&P 500 and buy the iShares S&P 500, but you could presumably sell the SPDR S&P 500 and buy, say, Vanguard Total Stock Market. You'll get a very similar investment experience, right, and you'll be able to harvest your loss.

Now the thing is 2009 was actually a rally year, so there weren't a whole lot of losses to go around in ETF land, depending on when you sold. I guess if you sold in March, you may still have some embedded losses. If you looked to sell in November or December, you wouldn't.

But I think with the new zeitgeist that's going on in Washington right now, and basically what we're looking at is higher taxes, higher cap gains taxes, I think there's a real development out there. Instead of thinking about harvesting losses, a lot of folks want to start thinking about harvesting gains.

So you had the rally in '09. You've got an ETF with an embedded gain. If you're worried about higher taxes down the road, and I do think that's a significant reality, you can sell that ETF now, take the gain at this lower tax rate.

There's no 30-day wash-sale rule on selling a gain, unlike a loss. If you sell something for a loss, you have to wait 30 days to buy it again. With a gain, you could sell the ETF, and presumably buy it an hour later and harvest that gain now.

Pay it now at this lower tax rate, and that way if they raise taxes in the future, you'll already have raised your cost basis. So in that new tax regime, you won't have as much of a liability.

So that's something I think people should really start to consider as they think about their overall long-term tax liability and managing that.

Glaser: Great, Scott. Some excellent tips to keep that tax bill down.

Burns: Thank you.

Glaser: From Morningstar.com, I'm Jeremy.