Exchange-traded funds (ETFs) can play a role in tax-loss harvesting strategies. When you take a loss on a security, the wash-sale rules prohibit buying back the same stock or fund within 30 days. Such a buyback would prevent you from claiming a capital loss on your tax return.
You can wait 31 days and then buy back the same security that you sold. If you’re out of the market for 31 days, though, you might miss out on a sharp upward move in the stock or fund you just sold.
One solution to this problem is to buy an ETF that correlates closely with the stock or the fund that was sold. Say you took a loss on a tech stock; you can immediately buy an ETF that tracks an index of tech stocks, such as the Technology SPDR. Buying a highly-correlated ETF won’t prevent you from reporting a capital loss on the tech stock you sold.
Then, if that tech stock runs up, chances are the tech ETF also will gain ground. After 31 days you can sell the ETF and go back into your original stock, if you wish, without forfeiting the capital loss you previously realized.
