Recent Sell off Presents Tax-Loss Harvesting Opportunity

The first quarter was not kind to the financial markets, but the good news is it presents an opportunity for tax loss harvesting. In a perfect world all investments go up, but in reality, if you own a well-diversified portfolio, you are likely to have some investments with a gain and some at a loss. This is where tax loss harvesting can be used. The concept is simple. Sell your security at a loss and then buy a similar security to replace your position in the market. The one catch is you cannot buy a substantially identical security within 30 days of the sale otherwise the IRS will not allow the loss.

Tax-loss harvesting works by taking advantage of investments that have declined in value. By selling investments that have declined below their purchase price a tax loss is generated. You can use this loss to offset other taxable gains, thus lowering your taxes. If you do not have any taxable gains, you can use the loss to offset up to $3,000 in non-investment income. Meaning if you made $100K from work this year, you would pay taxes on $97,000 now. Tax losses carry forward during your lifetime. So, if you have $10,000 of losses in 2020 and no capital gains, you can use $3,000 against your income this year and carry forward the excess losses.

Tax-loss harvesting only works in a taxable investment account. Retirement accounts like Traditional IRAs, Roth IRAs, and 401(k)’s is not eligible for tax loss harvesting. It would work in individual accounts, joint accounts, and taxable trust accounts.

An example would be if you have $15,000 taxable gain from the sale of a fund. If you have another fund that is a $15,000 loss, the loss will offset your gain and you will have no taxes due. You can also buy a similar fund, so you are not out of the market.

A second example would be if you own ETF that tracks technology stocks from provider A and sell it for a loss and simultaneously buy a similar ETF from provider B. This allows you to take the tax loss, but then keep your position in the market if it begins to rebound. Both ETFs track technology stocks so you would continue to have exposure in those areas. These ETFs are from different index providers, so they are not substantially identical.

Keep in mind the wash sale rule. This means you sell a security you must not buy back “substantially similar investment” within 30 days. If you do, the IRS will eliminate the benefits of a loss. An example would be if you owned ABC stock and it recently had a sharp decline, so you sold it to take the tax loss then bought it back in 30 days or less. If you want the tax benefits of the loss, the IRS requires you to wait 30 calendar days (not trading days) to buy it back.

In order to have a taxable gain you would need to sell your securities. If positions are held for more than a year those gains are taxed at the long-term capital gains rates (2020 rates below) instead of ordinary income rates. For positions held for less than a year, it will be taxed as ordinary income.

Tax-loss harvesting lowers your portfolio’s cost basis which will ultimately increase your taxable gains if your positions increase in value. Therefore, the ultimate value from tax loss harvesting is to defer taxes into the future. By keeping more of your money invested (instead of paying it out in taxes), your money can grow and compound through the years.

Please consult your financial advisor regarding your specific situation. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. 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. Stocks investing involves risk including loss of principal. Rebalancing strategies do not ensure a profit and do not protect against losses in declining markets. Rebalancing may cause investors to incur transaction costs, and when rebalancing a nonretirement account, taxable events may be created that may affect your tax liability.