Tax loss harvesting question

[insighter]

I was hoping someone could chime in on a tax loss harvesting question I have.

I recently got into the investing game and put in around $5k in Vanguard VTI and $5k into Betterment after putting it off getting in for a quite while. What tipped largely due to reading a MMM quote that these two investments were no brainers on his front page post.

"As of 2016, my own retirement income comes from a dead-simple asset allocation: a bunch of index funds at Vanguard and Betterment which pay quarterly dividends."
https://www.mrmoneymustache.com/2013/02/22/getting-rich-from-zero-to-hero-in-one-blog-post/

The confusion I have is that the MMM author states he uses Betterment's tax loss harvesting feature but that seems in contradiction to Betterment's advice. By that I mean according to their documents you are potentially ineligible if you have "substantially similar" holdings because you need to avoid the potential for a wash sale and the default Betterment investment portfolio mix includes Vanguard VTI. https://www.betterment.com/legal/tlh-disclosure/?_ga=2.114775175.1230569266.1577981802-845722993.1577981802

Is there something I'm missing about TLH? I'm not a savvy investor so I'm in the "set it and forget it" mode so I have a preference to simplify my investments in Betterment and not micro-optimize. I just want to at least make sure I'm setting things up intelligently.

Thanks in advance!

P.S. I'm not sure if my MAGI matters here, but my pre-tax non-equity salary income is around $130k.

[seattlecyclone]

The danger of enabling automated tax loss harvesting in Betterment for a security you also own elsewhere is that Betterment could sell that security for a loss at any time its algorithm deems appropriate. Ordinarily this might be a positive thing for your taxes as you would get to deduct the loss. However if you buy any shares of that same security within 30 days before or after Betterment sells some shares for a loss, you will then be disallowed from claiming that loss on your taxes due to the wash sale rule.

Betterment doesn't know about your external purchases, so it can't plan loss harvesting around them. Merely owning VTI in an external account won't get you in any wash sale trouble, but if you plan to buy more (even through automated dividend reinvestment) you'll want to make sure Betterment doesn't perform any loss harvesting within the relevant window before and after the purchase.

[MustacheAndaHalf]

Have you considered non-Vanguard ETFs for your Vanguard account?  Any ETF costs $0 to buy, $0 to sell at Vanguard.

For example, ITOT tracks the "S&P Composite" index under the "iShares" brand for an 0.03% expense ratio.
Meanwhile VTI tracks the "CRSP" index as a "Vanguard" fund that costs an 0.03% expense ratio.
Really, both own the largest ~3500 stocks, and should have indistinguishable performance.  But the IRS sees two different fund names, tracking two different indexes - they're different.

If you hold VXUS at Betterment, you could hold IXUS at Vanguard (another iShares ETF).  In general, iShares has a wide variety of low-cost passive index funds.  So they could make an excellent alternative that wouldn't trip over the wash sale rules (which require assets be "substantially identical").

One note, though: over time, stocks grow.  Enough years pass, and tax loss harvesting becomes less and less useful for the majority of your investments.  At that point, Betterment isn't giving you the same benefit - but they still extract the same fees.  So another approach could be moving everything to Vanguard to save the amount of Betterment's fee.  Or you could go to Schwab, which also features $0/trade on ETFs.

[EricEng]

If betterment doesn't know...IRS probably won't know either.  At our scale small mistakes like that just get lost in the noise.
https://www.palisadeshudson.com/2014/02/a-harsh-yet-hard-to-enforce-irs-position-on-wash-sales/
IRS wash sale depends on voluntary reporting as they have no way to report or track this.  So as long as you aren't intentionally trying to abuse I wouldn't worry if it happens in the background unintentionally.