Converting a Vanguard mutual fund to the ETF version - which approach is best?

alan14

I have not seen a clear answer to this question.  Vanguard allows for tax free conversions of its mutual fund share class to the ETF version.  I want to preserve all the individual transactions and dates and cost basis when I convert.  Should I be using the 'Mutual Fund conversion' approach, in which the new security is the ETF?  I have done this for converting Vanguard's Investor class shares to Admiral class and had no issues.  Or should I use  the 'Corporate Acquisition' approach, in which the ETF "acquires" the Mutual Fund?   Or do I end up with the same results regardless of this approach?  Appreciate guidance.  Quicken should really add a built in transaction like the ones I mentioned to make things easier.  As Vanguard's patent on this expires mid 2023, other companies may offer the same, so that there will be more demand for this feature.  Thanks in advance

NotACPA

Vanguard may CALL this a conversion, but I'll bet you that the IRS considers it to be a Sell and Buy. They're different securities.

alan14

Notacpa -  This is a taxfree exchange, for certain. The reason is that they are not different  securities - the investment pool is one and the same for the three classes of shares - Investor, Admiral and ETF.   This is exclusive to Vanguard (and with IRS approval for more than 20 years) unless another company has licenses the patent.

NotACPA

In which case a MF Conversion should work.  Best of luck ... but it still looks like a Sell/Buy to me.

alan14

Notacpa - Do you have idea of how the results differ between the 'Corp acquisition' and MF conversion? 

Separately, regarding the nontaxable nature of the exchange - I took this from Vanguard's website:   

Can I convert my conventional Vanguard mutual fund shares to Vanguard ETF Shares?

Yes. Most funds that offer ETF Shares will allow you to convert from conventional shares of the same fund to ETF Shares. (Four of our bond ETFs—Total Bond Market, Short-Term Bond, Intermediate-Term Bond, and Long-Term Bond—don't allow for conversions.)

Conversions are allowed from both Investor and Admiral™ Shares and are tax-free if you own your mutual fund and ETF Shares through Vanguard.

Keep in mind that you can't convert ETF Shares back to conventional shares. If you decide in the future to sell your Vanguard ETF Shares and repurchase conventional shares, that transaction could be taxable.

If you have a brokerage account at Vanguard, there's no charge to convert conventional shares to ETF Shares. If you own your Vanguard mutual fund shares through another broker, keep in mind that some brokers may not be able to convert fractional shares, which could result in a modest taxable gain for you. Other brokers may also charge a fee for a conversion. Contact your broker for more information.

Here's the Link - https://investor.vanguard.com/investor-resources-education/etfs/what-is-an-etf#:~:text=Conversions are allowed from both,Shares back to conventional shares.

Jim_Harman

I would use the Mutual Fund Conversion. It will only affect the shares in the current account, while the Corporate Acquisition will affect your holdings in other accounts as well.

Before entering the conversion, make sure the tax lots are correct and agree with Vanguard's accounting, especially if there have been partial sales. Also make sure Use average cost is NOT selected for the mutual fund. Due to a longstanding bug, Quicken will trash your cost basis if that is selected.

Be sure to back up your data before entering the conversion, in case something goes wrong or the result is not what you expected. You should delete or not accept any transactions that Vanguard downloads in connection with the conversion.

q_lurker

The primary difference between the two is the MF Conversion asks for number of new shares whereas Corp Acq requests a ratio.  The MF could thus come out more accurate (conceivably) though it may truly be a wash.  If the ratio is precisely 1.0, there should be no difference.

If the ratio is different than 1.0, I suggest reviewing each Add Share generated to make sure a consistent and desired precision on shares is maintained (I go for 0.001 share precision).  Being consistent can reduce the risk of odd fractional shares getting in the mix.  That advice applies to either of those two processes.    

alan14

Thanks Q_Lurker for explaining the difference between the 2 methods.  Jim_Harman, thanks also for explaining -  but why it is important for the tax lots to be same in quicken vs vanguard?  I assume I am going to delete all the transactions that are downloaded into Quicken regardless.  I am expecting to see a 'removed mutual fund shares' and 'added ETF' shares as downloaded transactions into Quicken.  Is this correct?

q_lurker

That expectation seems likely especially if the MF holding is already in a Vanguard brokerage account. 

Bob_L

Interesting!  For those interested, see Vanguard's  patent.  

@NotACPA: FYI, in the patent, the tax free nature of the conversion is explained because they are share classes of the same fund, which is the innovation Vanguard came up with in its patent.  It has apparently saved mutual fund holders from not getting hit with capital gains due to churning of ETF shares.

Jim_Harman

It is important to track the tax lots accurately because they affect how much capital gains tax you will pay when you sell the security. It also helps decide which lots to sell when you make a partial sale.

When you do a Mutual fund conversion in Quicken, you will see one Removed transaction for all of the shares of the old find and an Added transaction in the new fund for each tax lot you hold, thus preserving your detailed cost basis information.