Tax loss harvesting is a pretty straightforward concept – cut positions at a loss to lower clients’ overall tax bill today. Once out of a position for 30 days, you can get back in. But with stocks, sitting on the sidelines for 30+ days may not be possible or ideal.

That is where ETFs can help. ETFs offer an advantage in navigating tax loss harvesting and the im- plications of the wash sale rule because there are over 2300 ETFs to choose from. Savvy investors can swap out of a particular ETF and into another that gives them a similar but not identical exposure.

You can use ETFs to replace both mutual funds and other ETFs as long as they are not considered “substantially identical” by the IRS. If you are not certain whether a given ETF is too similar to another, you may be able to reference its index for guidance. If the ETF you wish to sell tracks the same exact index as the ETF you would like to buy, there is a decent chance that the IRS may deem the securi- ties too similar. Luckily, there are usually multiple indices to choose from when trying to get exposure to a particular asset class and/or market sector.

Since there is no shortage of ETF products on the market, you have ample choices when consider- ing a swap for the purposes of tax loss harvesting. Since there may be anywhere from five to ten ETFs that track similar and highly correlated indices, you can trade from one into another.

Here are some ways to pick the right ETF to optimize tax loss har- vesting:

Look for Correlation

Correlation is one important ele- ment to look at when choosing an ETF to make a tax loss pairs trade. One wants to ensure a high correlation to match the perfor- mance of the previous investment as closely as possible.

Measure the Active Share

Active share is a measure of ac- tive portfolio management that essentially tells how different a fund is from its benchmark. By choosing an ETF with a moderate degree of active share versus a reference ETF, one can stay within asset allocation guardrails while potentially not falling afoul of the wash-sale.

Tax matters when it comes to performance

When the market is riding high, and everyone is doing well, tax considerations may seem trivial. But as the market softens and tax laws increasingly look to target capital gains, a winning tax strategy can make all the difference between competing advisors.

Of course, consult a tax accountant for guidance on these matters as rules and tax rates are always changing.

For advisors looking for a free consultation on how to use Logicly to help with Tax Loss Harvesting, click here