Tax-Loss Harvesting

Jim Cantrell Jim Cantrell June 2, 2020

It may sound crazy, but there can be some benefit to market declines. While no one is ever hoping to lose money, market volatility is inevitable. The good news is, if you work with a Wealth Management firm such as Financial Strategies, Inc., we can help you implement  a Tax Loss Harvesting strategy in which you may be able to use the decline to your benefit by reducing your tax liability.

What is Tax-Loss Harvesting?

A Tax-Loss occurs when a security such as a stock or a mutual fund is sold for less than its purchase price. We harvest those losses to intentionally create a tax advantage. For example, say you purchased an individual stock for $5,000 and due to market conditions, the value today is $3,000. If you sell the stock, you realize a $2,000 loss. This loss can be used to offset your income for the year, in this case, by $2,000. Losses are fully deductible against gains. If losses exceed gains, then the IRS allows you to deduct up to $3,000 per year against Ordinary Income. If your realized losses for the year exceed $3,000, more good news, the difference can be carried forward to future years. We help our clients keep track of and manage this Tax-Loss Harvesting strategy. When executed correctly, this can be a big tax savings in the current year and in future years.

Keep in mind, this strategy only applies to investments in taxable accounts. This benefit is not available when selling at a loss in a tax-deferred account such as a 401(k), IRA or Roth IRA.

Wash-Sale Rules

There are limitations on Tax-Loss Harvesting. Wash-sale rules prevent investors from selling a security at a loss and buying back the same or a “substantially identical” security within 30 days and writing off the loss. It is important to fill the place of the sold security with a security similar enough to fill the needs of the portfolio and benefit when the depreciated asset class recovers. Keeping in mind that the new asset must be dissimilar enough that it is not considered substantially identical by the IRS to avoid wash-sale violations.

Effect on portfolio

Overall, the effect of Tax-Loss Harvesting is to take advantage of downturns in the market to reduce capital gains tax or ordinary income tax. This is especially beneficial to those in higher tax brackets. By buying back a similar, but not substantially identical, security, the portfolio stays balanced and relatively unaffected. You will still enjoy the upswing when that asset class eventually recovers, but you will get the added benefit of tax savings.

Working with a Fee-Only Financial Planner

The above is for informational purposes only and is not to be taken as advice.  Talk to a Fee-Only Financial Planner such as Financial Strategies, Inc. before doing any tax-loss harvesting to see if it is in your best interest.

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