Strategies for Success: Tax Loss Harvesting
Other Tax Smart blog posts that were developed from our presentation that you may be interested in reading are:
- Strategies for Success: Advisor’s Value
- Strategies for Success: Roth Contributions & Conversions
- Strategies for Success: How to enhance your tax savings from charitable giving with a Donor-Advised Fund (DAF)
- Strategies for Success: How Asset Location is Tax Smart
Selling an investment and taking a loss is painful but when done strategically there are big advantages. One such strategy is called Tax Loss Harvesting. When done properly, tax-loss harvesting turns your investment lemons into lemonade by converting market downturns into tax savings. A successful tax-loss harvest lowers your tax bill, without disrupting your portfolio allocation or altering your long-term investment outcomes.
If you sell all or part of an investment in your taxable account when it is worth less than you paid for it, this generates a realized capital loss. You can use that loss to offset capital gains and other income in the year you realize it, or you can carry it forward into future years. We can realize losses on a holding’s original shares, its reinvested dividends, or both.
When harvesting a loss, it’s imperative that you remain true to your existing portfolio allocation. To prevent a tax-loss harvest from altering your allocation, we simultaneously reinvest the proceeds of the sale into a similar investment. We may keep the new investment as part of the portfolio, or we can buy back the original investment after 31 days.
The Tax-Loss Harvest Round Trip
In short, once the dust has settled, our goal is to have generated a capital loss to report on your tax return, without dramatically altering your market allocation during or after the event. Here’s a 2-step but sometimes 4-step summary of the round trip typically involved:
- Sell all or part of an investment in your portfolio when it is worth less than you paid for it.
- Buy a similar (not “substantially identical”) investment.
- Sell the new position after 31 days.
- Buy the original position.
An effective tax-loss harvest can contribute to your net worth by lowering your tax bills. That’s why we keep a year-round eye on potential harvesting opportunities, so we are ready to spring into action whenever market conditions and your best interests warrant it.
That said, there are several reasons that not every loss can or should be harvested. Here are a few of the most common caveats to bear in mind.
Market volatility – When the time comes to sell the interim holding and repurchase your original position, you ideally want to sell it for no more than it cost, lest it generate a short-term taxable gain that can negate the benefits of the harvest[JD1] . We may avoid initiating a tax-loss harvest in highly volatile markets, especially if your overall investment plans might be harmed if we are unable to cost-effectively repurchase your original position when advisable.
Tax planning – While a successful tax-loss harvest shouldn’t have any impact on your long-term investment strategy, it can lower the basis of your holdings once it’s completed, which can generate higher capital gains taxes for you later on. As such, we want to carefully manage any tax-loss harvesting opportunities in concert with your larger tax-planning needs.
Asset location – Holdings in your tax-sheltered accounts (such as your IRA) don’t generate taxable gains or realized losses when sold, so we can only harvest losses from assets held in your taxable accounts.
Adding Value with Tax-Loss Harvesting
It’s never fun to endure market downturns, but they are an inherent part of nearly every investor’s journey toward accumulating new wealth. When they occur, we can sometimes soften the sting by leveraging losses to your advantage. Determining when and how to seize a tax-loss harvesting opportunity, while avoiding the obstacles involved, is one more way we seek to add value to your end returns and to your advisory relationship with us. Let us know if we can ever answer any questions about this or other tax-planning strategies you may have in mind.
Some of the material above was provided by Wendy J. Cook Communications, LLC