Tax exemption on VTEB and VWIUX - holding periods for tax loss harvesting (TLH)?

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spartan19
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Joined: Wed Jan 12, 2022 1:06 am

Tax exemption on VTEB and VWIUX - holding periods for tax loss harvesting (TLH)?

Post by spartan19 »

Hello, I want to buy tax-exempt bonds for my brokerage account instead of BND or TIP to avoid tax impact on dividends. I live in WA state in case it is relevant.

Reading forums and doing some research, I found two options:
* VTEB - Vanguard Tax-Exempt Bond ETF
* VWIUX - Vanguard Interm-Term Tx-Ex Adm

I am leaning towards VTEB since it has no commission fees and I prefer ETF over mutual funds. However, I am confused by some comments on this forum about the need of holding the position for 6 months in order to receive the tax exemption (apparently due to monthly accrual) vs VWIUX having no such restrictions (because they have daily accrual?). I tried to find more information about this but was unable to locate anything about the hold period needs, accrual periods and potential impacts on the exemption.

Can someone please help either point to some references or share their experience? Is there also any impact on tax harvesting (outside of standard wash sale rule)? Thank you all in advance
Last edited by spartan19 on Mon Jan 17, 2022 1:20 am, edited 1 time in total.
sycamore
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Re: Tax exemption on VTEB and VWIUX - holding periods?

Post by sycamore »

Welcome to the forum!

The Bogleheads wiki on municipal bonds has a section of interest: https://www.bogleheads.org/wiki/Municip ... s.2Flosses

It's about claiming whether you can claim a capital loss, not about tax exemption of the dividends themselves.

Maybe this is what you're looking for?
Topic Author
spartan19
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Joined: Wed Jan 12, 2022 1:06 am

Re: Tax exemption on VTEB and VWIUX - holding periods?

Post by spartan19 »

Thank you that is helpful however I want to verify the information and understand the rules but I can't find much information. When I called Vanguard, they did not know anything about the 6-month hold period (or accrual differences) in order to claim losses, all they referred me to was a wash sale rule (30 days before and after).

Reading through IRS page I found one quote: "Exempt-interest dividends on mutual fund stock.
If you received exempt-interest dividends on the stock, at least part of your loss is disallowed. You can deduct only the amount of loss that is more than the exempt-interest dividends. Report the loss as a short-term capital loss. On Form 8949, Part I, line 1, column (d), increase the sales price by the amount of exempt-interest dividends, but do not increase it to more than the cost or other basis shown in column (e)."

But nothing about holding periods or accruals either.
nrkv
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Re: Tax exemption on VTEB and VWIUX - holding periods?

Post by nrkv »

I asked similar question few months back, which you probably read. viewtopic.php?f=1&t=360313

I couldn’t find any reference for tax exempt dividends and 6 months rule in IRS publication. The link in bogleheads site referring to fairmark.com does not exist anymore; maybe IRS changed rules in past few years and this wiki has to update information?
increment
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Re: Tax exemption on VTEB and VWIUX - holding periods?

Post by increment »

spartan19 wrote: Wed Jan 12, 2022 10:39 am Reading through IRS page I found one quote: "Exempt-interest dividends on mutual fund stock.
If you received exempt-interest dividends on the stock, at least part of your loss is disallowed. You can deduct only the amount of loss that is more than the exempt-interest dividends. Report the loss as a short-term capital loss. On Form 8949, Part I, line 1, column (d), increase the sales price by the amount of exempt-interest dividends, but do not increase it to more than the cost or other basis shown in column (e)."

But nothing about holding periods or accruals either.
You can see more clearly on page 54 of the Publication 550 PDF that this is one of the "special rules" that apply if "you hold stock in a mutual fund (or other regulated investment company) or REIT for 6 months or less and then sell it at a loss".
hudson
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Re: Tax exemption on VTEB and VWIUX - holding periods?

Post by hudson »

spartan19

Daily accrual discussion...scroll down for list of Vanguard funds that use daily accrual

viewtopic.php?p=6403352#p6403352
Topic Author
spartan19
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Joined: Wed Jan 12, 2022 1:06 am

Re: Tax exemption on VTEB and VWIUX - holding periods?

Post by spartan19 »

Thank you all for great responses.

I found most helpful information in this forum: viewtopic.php?t=365344. Quoting the most relevant reference:
The 6 month rule for tax exempt interest comes from 26 U.S. Code § 852(b)(4)(B), but there is an exception in 852(b)(4)(E) for funds that declare dividends daily and pay them monthly or more frequently.
I researched those in the https://www.law.cornell.edu/uscode/text/26/852 and found the following supportive quotes:

26 U.S. Code § 852(b)(4)(B)
(B) Loss attributable to exempt-interest dividend
If —
—(i) a shareholder of a regulated investment company receives an exempt-interest dividend with respect to any share, and
—(ii) such share is held by the taxpayer for 6 months or less,
then any loss on the sale or exchange of such share shall, to the extent of the amount of such exempt-interest dividend, be disallowed.

26 U.S. Code § 852(b)(4)(E)
(E) Exception to holding period requirement for certain regularly declared exempt-interest dividends
— (i) Daily dividend companies
Except as otherwise provided by regulations, subparagraph (B) shall not apply with respect to a regular dividend paid by a regulated investment company which declares exempt-interest dividends on a daily basis in an amount equal to at least 90 percent of its net tax-exempt interest and distributes such dividends on a monthly or more frequent basis.
As discussed in multiple forums, I couldn't find any ETFs with daily accrual (only monthly), so mutual funds are the only way how to avoid the above rule. After all the considerations, I was choosing between the following three:
  • VTEB: Vanguard's index ETF, no transaction fee at Fidelity, has to disallow tax-exempt interest from position's loss if held less than 6 months.
  • VWIUX: Vanguard's index mutual fund, $75 transaction fee at Fidelity, allows for any TLH (except regular wash sale rule).
  • FTABX: Fidelity's actively managed mutual fund, no transaction fee at Fidelity, higher expense (.25%), also allows for any TLH, over-indexed on Illionis
In the end, I am going to go with VTEB for the following reasoning - I plan to be adding to bond funds regularly and want to avoid any transaction fees which would make it a pretty costly investment. Secondly, I don't plan to use bonds as a TLH mechanism. And in case I really lose a fair amount on a position I hold under 6 months, I am ok with disallowing interest accrued on the positions since in theory we are talking about less than 1% of the position's cost basis disallowment based on historical data (current 12-Month Yield 1.64%, so talking about max 0.82% if distributed equally).

If you have any more observations or find holes in my logic, please share, I would love to learn what I have missed.
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