What is tax-loss harvesting?

It’s basically realizing a capital loss while maintaining the same exposure. For instance, if in your portfolio, there is a U.S. equity fund with losses of $50,000, you can sell the fund, realize the loss and buy a substantially similar U.S. equity fund to take its place. This way you maintain the same exposure but book an accounting loss of $50,000. This maneuver is called tax-loss harvesting.

What's the value of tax-loss harvesting?

The loss you realize can be used to reduce future income or capital gains taxes. Rather counterintuitively, investment losses are thus an asset to be harvested. Let’s use an example to illustrate the point.

Assume you realize a $50,000 loss from selling the above-mentioned U.S. equity fund. Then, let’s assume you realize a gain of $60,000 in the next year and are subject to a capital gains tax of 20%, or $12,000. Rather than paying the tax on the full $60,000 gain, you can use the $50,000 in capital losses that you harvested to offset a portion of the gain. By offsetting $50,000 of your gain with the prior year’s loss you will only owe capital gains tax on $10,000, or $2,000. That’s a tax savings of $10,000!

What if you don’t have any capital gains to offset? You can use the loss to offset your income, but only up to $3,000 per year. The unused portion of the loss can be deferred indefinitely into the future. So, the $50k loss can be used to offset $3,000 worth of income for the next sixteen years. For folks in the highest tax bracket, whose marginal tax rate – combined federal, state, and local – is approaching 50%, the tax-saving each year would be $1,500, or $24,00 over sixteen years.

To sum up, by harvesting $50,000 in losses, you could save $10,000 in capital gains tax or up to $24,000 in income tax. This is also an advantage to owning mutual funds vs individual stocks. Most investors prefer not to sell an individual stock at a loss knowing they cannot buy back the same stock for 90 days in order to recognize the loss for taxes. With mutual funds you can sell a U.S. Equity fund at a loss and buyback, the same day, any other US Equity fund.

Don’t let a loss sit in your investment account- it’s a wasted opportunity to save on taxes.

Charlie Massimo

Charlie Massimo

Senior Vice President, Financial Advisor

Series 3, 7, 24, 63* & 65 Advisory Registrations† For three decades Charlie served at top firms Shearson Lehman, New York Life and Merrill Lynch, culminating in a role as a Senior Investment Officer at Smith Barney. In 2003, Charlie launched CJM Wealth Management, where he focused on a wide range of issues from tax and estate planning, to life insurance and the use of trusts. While Charlie works with various high-net worth families, he also has a strong concentration...Read More