The ABC's of Tax Loss Harvesting

As an investor, you always want and expect your investments to grow in value. Sometimes however, they just don’t. When this happens, there are still ways to turn a market downturn into a positive. For example, you can purchase high quality investments at discounted prices. Another example is to use an advanced investment strategy called “Tax Loss Harvesting” or “Tax Loss Selling”.

For some investors, especially those in the high tax brackets, tax gain/loss harvesting is the single most important tool for reducing taxes now and in the future. When properly applied, it can save you taxes and help to diversify a portfolio in ways that may not have been considered. The losses harvested can be used to offset taxable gains within the portfolio and in some cases can be used to offset ordinary income.

Here is how tax loss harvesting works: When you sell an investment in a taxable account for less than you paid at purchase, you create a capital loss for tax purposes. This loss can be used in two ways: offsetting
investment capital gains and/or reducing ordinary taxable income. Under the current tax law, if your loss is more than your gain, it can reduce earned income up to $3,000 per year ($1,500 for anyone who’s married and filing taxes separately). But it gets even better in the event you have reported losses of more than $3,000, because the remaining losses can be carried forward into future tax years.

For example, after reviewing your portfolio you decide to sell an investment locking in a $5,000 capital gain. This taxable event can be offset by selling one or more investments totaling a $5,000 capital loss, which in this
example could save you as much as $1,980 in taxes if you’re in the top 39.6% tax bracket. When done properly and when the portfolio is evaluated frequently for tax loss harvesting opportunities, it can add up to big tax savings for some investors.

Now let’s evaluate the previous example, but harvest a $9,000 tax loss. The $5,000 offset to the capital gains would remain unaffected, but you would now be left with $4,000 in net capital losses. You would then use it to reduce taxable income up to the IRS limit of $3,000 in the current year. The remaining $1,000 capital loss is then carried forward to the future tax year. 

The concept is a simple one to understand but using it in the real world can be tricky. The IRS has what’s called the “Wash Sale Rule” which prevents you from selling and purchasing the same investment within 30 days. Also, long-term losses are first used to offset long-term gains and then short-term gains; short-term losses are used to offset short-term gains and can then be used against long-term gains. You are encouraged to work closely with your tax professional.

Many financial advisors don’t even discuss tax loss harvesting with clients that would benefit from the strategy. Many others only talk about harvesting losses at years end before taxes are due and paid. That’s fine for
some clients, but it’s more advantageous to be looking for tax loss opportunities throughout the entire year, especially in a year when the markets are volatile. It’s possible tax-loss harvesting opportunities will arise early in the year, only to disappear by years end.

If you’re in a tax bracket of 25% or higher, and this is the first time that you are hearing about this investment strategy, I highly encourage you to call me. We cater to investors who are tax conscious and desire a high level of customer service. For a complementary consultation to see if tax loss harvesting might be an added benefit for your particular situation, give me a call.

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