By Mark Hulbert, MarketWatch
Beat the wash sale rule at its own game
The last couple of weeks of the year are when stock investors would be wise to consider strategies for reducing the tax bill that would otherwise be due on any capital gains realized since Jan. 1.
The most obvious is to sell some of your losers, since the resultant losses can be used to offset the gains and reduce or even eliminate the tax otherwise due. But the IRS" so-called "wash sale rule" may be discouraging you from doing so. Fortunately, there are ways of getting around that rule.
First some background: In order to have their maximum tax benefit, losses that you realize should be on stocks you've held for less than one year. And, according to the wash sale rule, you must stay out of the stocks you've sold for at least 30 days.
That's the rub: The 30-day period from mid-December to mid-January is often one of the most favorable for beaten-down stocks. Many investors are reluctant to dump their losers right before they may rebound.
The key to getting around the wash sale rule is to find another stock or group of stocks that over the trailing 12 months have been highly correlated with the one you've sold. You then can sell your losing stock, invest the proceeds in the substitutes, and then reverse these transactions in a month's time. The assumption behind this strategy, of course, is that securities that are highly correlated with each other over the trailing 12 months are likely to remain highly correlated for another 30 days.
Even if your substitutes are imperfectly correlated with the stock you have sold, your reduced tax bill will make it more than worth your while to pursue such a strategy. I calculate that the stock you sold will have to do 28% better than your substitutes over the 30-day wash-sale-rule period in order for you to be worse off for harvesting your tax loss.
Finding highly correlated substitutes is relatively straightforward. The first place to look is the free "Correlation Tracker (http://www.sectorspdr.com/sectorspdr/tools/correlation-tracker/multiple-securities)" available at the Select Sector SPDR website, which shows you the correlation coefficient between the stock you're thinking of selling and each of the 10 "Select Sector" SPDR ETFs.
To interpret what is reported on that site, bear in mind that the correlation coefficient will be 1.0 if there has been a perfect correlation between the stock in question and a SPDR ETF. A 0.0 coefficient means there has been no correlation. For purposes of the strategy to beat the wash sale rule, you want to find a SPDR ETF with a correlation coefficient of at least 0.7.
If no such ETF is available, then you should find those individual stocks that are most correlated. A free utility on the Finance Boards website (https://financeboards.com/blog/widget-spotlight-20-the-companys-most-correlated-stocks-widget/) will report, for any stock, the 10 others that have been most highly correlated with it over the trailing 12 months. Pick two or three stocks at the top of the list and purchase them as a package with the proceeds of the stock you've sold.
Consider the example I used one year ago in a column on this subject (http://www.marketwatch.com/story/why-you-should-dump-that-loser-stock-in-2017-and-harvest-the-tax-loss-2017-12-18): Range Resources (RRC) , which at the time the column was published (Dec. 18, 2017) was sporting a year-to-date loss of 53.5%. Over the subsequent 30 days -- the required length of time to stay out of the stock in order to take full tax advantage of that 53.5% loss -- the stock gained 5.5%.
As fate would have it, the substitutes I mentioned in last year's column did better that Range Resources. The Select Energy SPDR (XLE) , gained 11.4% over the same 30-day period, and the three individual stocks that were mentioned gained an average of 23.8%. So in this particular case you received a double benefit -- not only harvesting a short-term loss but also making more money with your substitutes than with your original stock itself.
It's unrealistic to expect you'll be this lucky every time, of course. But you get the idea.
What about this year? By way of illustration, the table below lists the five stocks in the S&P 500 with the biggest year-to-date losses (as of Dec. 12). For each stock I show the Select Sector SPDR and the three individual stocks with the highest 12-month correlations.
YTD loss Most highly-correlated Select Sector SPDR (with correlation coefficient in parentheses) 3 stocks most highly correlated (with correlation coefficient in parentheses)
Coty Inc. US:COTY -60.3% XLB (0.31) EVOL(0.96)HDSN (0.95)OC (0.95)
General Electric US:GE -60.2% XLE (0.43) DVCR (0.93)FLXS (0.92)PBYI (0.92)
Mohawk Industries US:MHK -56.8% XLB (0.52) IPCI (0.97)BECN (0.97)NWHM (0.96)
Affiliated Managers Group US:AMG -51.2% XLF (0.84) IVZ (0.98)BECN (0.97)CAJ (0.97)
Newfield Exploration US:NFX -50.6% XLE (0.73) WFT (0.89)VET (0.88)INN (0.87)
For more information, including descriptions of the Hulbert Sentiment Indices, go to The Hulbert Financial Digest (http://hulbertratings.com/) or email email@example.com (mailto:firstname.lastname@example.org).
More: The wash sale rule is a nasty little piece of tax code (http://www.marketwatch.com/story/understanding-the-wash-sale-rules-2015-03-02)
-Mark Hulbert; 415-439-6400; AskNewswires@dowjones.com
(END) Dow Jones Newswires
December 18, 2018 17:18 ET (22:18 GMT)
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