What question did this study set out to answer?

This research aims to explore the use of exchange-traded funds (ETFs) by institutional investors to bypass wash sale rules and recognize capital losses.

April 5, 2026

Exchange-Traded Funds and the Wash Sale Loophole

Key Points

This research aims to explore the use of exchange-traded funds (ETFs) by institutional investors to bypass wash sale rules and recognize capital losses.
Analyzed trading patterns of institutional investors in ETFs
Examined the creation of shares and trading volumes of existing ETFs when new, similar ETFs were introduced
Assessed the volume of ETF swapping among tax-sensitive institutions since 2001
Tax-sensitive institutions have swapped $417 billion of nearly identical ETFs since 2001
Institutions holding more ETFs are more likely to engage in this swapping behavior
An estimated $84 billion in losses were realized from swapping highly correlated ETFs since 2001

Abstract

Tax wash sale rules prohibit the recognition of capital losses when substantially identical securities are sold and immediately repurchased within short windows. This study examines whether institutional investors use exchange-traded funds (ETFs) to circumvent wash sale rules. Consistent with tax-motivated demand for ETFs, incumbent ETFs both create more shares and experience more trading volume upon the introduction of nearly identical ETFs, particularly when recent returns are negative. We show that tax-sensitive institutions’ investment in highly correlated ETFs has proliferated in recent years, exceeding a quarter of their assets under management. Furthermore, tax-sensitive institutions holding more ETFs are significantly more likely to engage in swapping nearly identical ETFs. This swapping behavior has become widespread, with tax-sensitive institutional investors swapping 417 billion of nearly identical ETFs since 2001. We estimate that tax-sensitive institutions realized more than 84 billion dollars in losses in highly correlated ETFs associated with the swapping activity since 2001. This paper was accepted by Shiva Rajgopal, accounting. Funding: The authors thank their institutions for financial support. M. Dambra thanks the Kenneth W. Colwell endowment for research support, C. M. C. Lee thanks the Kermit O. Hanson endowment for research support, and P. J. Quinn thanks PricewaterhouseCoopers for research support. Supplemental Material: The online appendix and data files are available at https: //doi. org/10. 1287/mnsc. 2024. 06944.

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