With the recent extensions of federal tax filing and payment deadlines, your taxes may not be due until July. But now might be a good time to think about “tax-loss harvesting” to limit the recognition of short-term capital gains that are typically taxed at a higher federal income tax rate than long-term capital gains.
Tax-loss harvesting cannot restore losses, but it can mitigate them. In short, you can sell Security A at a loss to offset the capital gains tax liability on Security B and lower your personal taxes—if the sales meet certain conditions.
With that in mind, here are six essential tax-loss harvesting tips:
1. You Don’t Need to Wait Until the End of the Year
You might think you have until the very end of the year to address this situation, but as far as the tax year goes, you don’t.
This is because the IRS does not approve of buying and selling an asset simply to lower your taxes. Called the “wash-sale rule,” a loss will be disallowed if the same asset/security is sold for a loss and repurchased within 30 days (as you must report on Schedule D of the 1040 tax form). In certain cases, that 30-day period can expand to 61 days or, if you want to stay invested in the same security after declaring a loss, 30 days after the initial purchase date and then another 30 after the date of the sale.
Let’s say you love a certain stock and want to stay in it for the long haul, but right now the stock is down substantially from your purchase price. To avoid a wash sale, if you bought it more than 30 days ago, you can sell it, otherwise you need to wait for those 30 days to elapse. Then, you need to wait 31 days to elapse before you can repurchase it.
However, if you simply want to stay invested in the same sector (say, software and services), you do not need to wait to reinvest the same dollar amount in an equivalent asset. So, you could take the proceeds from that first stock sale and at any time invest them into another stock in that sector.
2. Leverage Bouts of Market Volatility
While no one likes to see their balance fluctuate during periods of market volatility, if you have significant losses in your portfolio, you can “bank” those losses now to offset future gains as the markets recover. Measure the gains and losses now (or have your financial advisor do it) and keep an eye out for moves in those securities over the next month or so to enhance your opportunity to make a tactical exit.
3. There is No Limit on Losses You Can Harvest
There’s no limit on the amount of capital losses that can be applied against capital gains. However, only $3,000 of it can be applied against ordinary income for the tax year with the balance carried forward. That said, the time value of money means that the tax liabilities in the future should be less costly than the liabilities you face now.
4. The Wash-Sale Rule Applies Across Your Portfolio
You need to apply the wash-sale rule across your portfolio, including non-taxable accounts and spousal accounts. This means if you sell individual holdings of a certain stock, you cannot buy another block for your IRA or your spouse’s IRA without waiting until 30 days after the sale. It also means that if you recently purchased a security for your IRA, you need to wait the 30 days before selling individual holdings of it in a taxable account to receive the full amount of capital loss.
5. Watch Your Transaction Costs
While we are all about maximizing tax efficiency, it makes no sense to throw cost efficiency out the window in an attempt to reach maximum tax efficiency. Buying and selling have transaction costs that need to be balanced with how much you can save in taxes.
6. Its Effectiveness Depends on Your Portfolio
The effectiveness of tax-loss harvesting can vary depending on the composition of your portfolio. For instance, if you’ve taken a look over your investment portfolio’s performance this year, you likely have registered some gains in equities and may have some losses in fixed income. In such a case, you might consider selling some fixed income assets, as well as any stocks that have dropped substantially.
The overall goal, of course, is to keep more of what you make. It’s not too late to prepare and take steps to optimize your portfolio for tax efficiency. When the market hands you lemons, Uncle Sam allows you to turn it into lemonade by creating a tax benefit.
If you have more questions about tax-loss harvesting, we’re here to help. Reach out to a financial advisor today to get a clearer understanding of your tax-loss harvesting options.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
Series 7 & 63 Securities Registrations,1 Series 65 Advisory Registration† Chris has advised high-net-worth families and institutions since 2001. In his role, he incorporates his extensive knowledge managing public and private investments, including private equity and real estate. Prior to joining Wealth Enhancement Group, Chris was a portfolio manager and principal for a Dallas, Texas-based RIA, where he oversaw due diligence and portfolio management and...Read More