When you sell an investment, you cannot claim a loss for tax purposes if you repurchase a substantially identical investment within 30 days.
But investors have found a way around this law by using exchange-traded funds (ETFs) to essentially bilk the government out of billions of dollars of tax revenue, according to a recent analysis.
Research from the University at Buffalo School of Management found that investors are selling one ETF — a group of stocks, bonds or other securities — for the purposes of claiming a loss, then quickly purchasing a second ETF nearly identical to the first.
To date, the IRS has not clarified whether this practice is legal or illegal, according to study co-author Michael Dambra, an associate professor and the chair of accounting and law in the UB School of Management.
For their study, Dambra and other researchers at UB analyzed two decades worth of ETF trading data, from 2001-2022. The researchers estimate that during that period, investors swapped around $417 billion of nearly identical ETFs. And the practice has picked up steam in recent years. In 2022 alone, investors swapped around $106 billion in nearly identical ETFs.
In a summary of the study findings, Dambra says:
“Currently, financial advisors are navigating a foggy legal landscape, with some advisors taking regulatory silence as tacit permission to swap ETFs that hold identical securities, while others argue that if an investor’s economic position has not changed, the spirit of the tax law has been violated.”
Dambra is calling on the IRS to release clearer regulations in regard to the legality of the ETF strategy.
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