In Print: Volume 88: Number 1
New Twists on an Old Plot: Investors Look to Avoid the Wash Sale Rule by Harvesting Tax Losses with Exchange-Traded Funds
By Garrett M. Fischer
88 Wash. U. L. Rev. 229 (2010)
On October 7, 2007, all seemed well on Wall Street as the Dow Jones Industrial Average (DJIA) set a “record high,” closing at 14,164. But, as expressed by Sir Isaac Newton, “what goes up must come down.” And the U.S. stock markets came plummeting down at record pace, declining by over fifty percent “for the second time this decade.” As a result, the decline of the DJIA alone led to $11.2 trillion of investment losses between October 2007 and March 2009, contributing to over $2 trillion of losses in U.S. “retirement savings.” As multiple financial institutions failed and “credit markets froze,” investors “fear[ed] another Great Depression.”
Investors have traditionally been able to capitalize on long-term increases in the value of stocks by utilizing the simple strategy of “buying low and selling high.” However, now that the United States is “facing one of the largest financial crises in history,” investors may look to maximize their returns through more creative investment strategies. Accordingly, this Note will analyze the proper taxation with respect to the Wash Sale Rule (26 U.S.C. § 1091) for investors who creatively use contemporary investment mechanisms, known as exchange-traded funds (ETFs), to minimize the effects of capital losses through a process known as tax loss harvesting.
Part I of this Note will provide an introductory explanation of tax loss harvesting, followed by an introductory explanation of the Wash Sale Rule in Part II. Then, in Parts III and IV, respectively, this Note will provide an explanation of ETFs and their history. In Part V, this Note will provide an in-depth discussion of the statutory language and administrability of the Wash Sale Rule. Finally, Part VI of this Note will provide an explanation as to why a proper analysis of ETFs under the Wash Sale Rule should entail a look at the underlying holdings of each ETF to determine if the funds are economically similar.