the fly in my 'Betterment - tax loss harvesting' ointment

[rmisio]

I'm really intrigued by Betterment, particularly their tax loss harvesting feature. However, there's one aspect that is holding me back from taking the plunge. I currently have a Vanguard account (both brokerage and retirement) and I'd like to keep it. I'm a bit worried about 'wash sales'.

http://support.betterment.com/customer/portal/articles/1595496-how-do-i-safely-use-tlh-if-i-have-external-accounts-

The above article (sorry not understanding how to link here) on their support page gives a lot of tips on how to avoid them, but it seems complicated. I'd need to know when Betterment did the harvesting and then ensure no “substantially identical” security is purchased in my Vanguard account (including the re-investing of dividends). It goes on to elaborate about what exactly is “substantially identical”, which would seem to require me to know much more about my investments than I do now, like what index they follow (I mostly have a Lazy portfolio - currently Andrew Tobias's).

Anyhow, if anyone can offer me a different perspective on my dilemma, I'd very happily welcome it. I may very well be over-thinking things here. Basically, is there a way to reap the benefits of Betterments tax loss harvesting, without having to jump through hoops to avoid wash sales? Is having a wash sale here and there such a big deal that it would counteract all the benefits of the tax loss harvest?

[seattlecyclone]

Why not harvest losses yourself in your Vanguard account? It's not rocket science. Just log in once in a while, click on the "cost basis" link on the "balances and holdings" page, and see if any positions are currently in the loss territory (helpfully highlighted in red for you). Sell the losers and switch to a slightly different fund for at least a month.

To avoid loss sales, turn off dividend reinvestments in all accounts (even your retirement accounts) for any funds that you own in your taxable account. Only (re)invest into funds that you have not harvested losses within a month, and avoid harvesting losses in that fund for at least a month afterward.

[MustacheAndaHalf]

A wash sale only matters for a loss.  If you have a gain, the IRS is perfectly happy having you pay the tax on the gain.  But the IRS doesn't want to share your loss when you're both buying and selling the same asset around the same time (30 day window).  So that's the wash sale rule - delaying losses the IRS would have shared.

I personally don't feel this is an IRS priority.  The IRS doesn't bother to explain "Substantially identical" for mutual funds.  Can you sell Vanguard Total Stock Market and buy S&P 500?  Probably, since there's about 30% difference in composition there.  That's actually what I do - when I sell Total Stock Market, and within 30 days need to buy it back, I buy S&P 500 instead.  If small caps rise quickly, I lose out - because they are not identical.  But it's close, and I doubt it violates the IRS rule on wash sales.

As to the Betterment article, let's walk through that a moment.  You sell Vanguard Total Stock at Betterment, and you buy it at Vanguard.  It has to be a loss, or the IRS doesn't care.  So it's a loss.  The IRS puts full responsibility for detecting and reporting this on you.  To me, that's a poor mechanism for such a subtle rule, but that's what it is.  Betterment doesn't want to be responsible if you fail to report it.  If you go through an audit and the IRS flags this, they'll say you could not have taken a loss at that time.  But if you sold Total Stock Market later, you could then deduct the loss.  So maybe the 2014 audit says it's a wash sale, and since you sold it the next year, you update your 2015 taxes to reflect the loss happening then instead (the wash sale adds to the cost basis so that when you sell, you have a big cost basis and wind up with the earlier loss being realized).

It's a lot of trouble for the IRS to get you to delay a tax loss a year or two.  So let's say you sold $15,000 of securities and realized a $2,000 loss.  And in the 25% tax bracket, you pulled $500 from the IRS that should have been theirs.  And when the audit happens, you just sell the asset you bought, and the $500 loss pops out again in that tax year.  So maybe you owe interest or late charges on the $500.  Do they use 3%/year?  ($15 on $500).  I think if a problem develops, you're talking about a 1% problem relative to the loss.

So that's the best I can describe it - it's less of a concern than Betterment makes it out to be.  I think that article is written for either the IRS or lawyers, not you.  If a case comes up, they want to point to that article and blame the individual investor instead of taking the impact on themselves.