Tax Loss Harvesting Season: What You Need To Know

Forbes.com, Winter, 2017. This article was written with Jim Cahn, the Chief Investment Officer at Wealth Enhancement Group. It was part of a series of articles developed under an agreement with Forbes to work with a variety of contributors and assist them in delivering actionable investment ideas each week. The site forbes.com is one of the top 500 sites in the world with nearly 10 million subscribers and nearly 100 million page views a month.

The April deadline for filing taxes can be misleading. Some filers are lulled into thinking that decisions about their taxes can be made next year. That can be true, but only in some cases. Now is the time to decide whether you should do any tax loss harvesting to limit your capital gains this year. 

In short, tax loss harvesting targets matching gains and losses to reduce the tax you pay on capital gains, sometimes dramatically, if the sales meet certain conditions. Because there is no limit on the amount of capital losses that can be applied to capital gains, tax harvesting is a potentially massive opportunity that every investor should consider. Tax loss harvesting cannot turn a loss into a gain, but it can mitigate your losses by reducing your tax liability.

Even better, any remaining tax losses can be used to reduce your overall regular income taxes at a rate of up to $3,000 each year until the losses are exhausted. 

Here’s what you need to keep in mind before you execute a tax loss harvesting strategy:

Assess your current gains/losses. Measure your year-to-date gains and losses now so that you have a baseline and understanding of what you could achieve with tax loss harvesting, and what you could not. For instance, if you have $50,000 in overall gains and $1,000 in losses, or vice versa, it would be good to know this going into a tax loss harvesting exercise and to temper your expectations accordingly.  

A few words of caution or perspective on tax loss harvesting. First, its effectiveness will vary from portfolio to portfolio and from year to year. For instance, 2017 is shaping up to be a good year for stocks. At a broad brush level that means lots of gains, but maybe not so many losses available to offset them.  

Similarly, a portfolio with concentrations might deliver some unusual harvesting challenges. For instance, if your portfolio was heavily weighted toward retailing in 2017, unless you owned Amazon, you likely have losses and perhaps few gains. If your portfolio was overweight technology, you may have lots of gains, and maybe few losses to offset them. 

Of course, if you hold both of these sectors in prudent allocations, the combination might be just right for fruitful tax loss harvesting. And if that’s not solid plug for a diversified portfolio, I don’t know what is.      

Be mindful of “wash sale” rules. The IRS prohibits the selling and buying of an asset simply to lower your taxes. Per the “wash-sale” rule, a loss will be disallowed if the same or “substantially identical” asset/security is sold for a loss and re-purchased within 30 days (as reported on Schedule D of the 1040 tax form). Note that this rule applies to your own accounts (taxable, tax-deferred and tax-advantaged) and those of your spouse. 

To further complicate matters, the IRS’s “30 days” can really be a total of 61 days or more. If you want to stay invested in the same security after declaring a loss you must own it for 30 days after the initial purchase date and then avoid owning it for another 30 after the date of the sale. It’s prudent to exercise extreme caution if your objective is to repurchase the asset you’ve just sold.  

While we’re touching on wash-sale rules, it’s also worth noting that these rules don’t apply to realizing gains. Gains are able to be realized, with the immediate repurchase of the same security fully allowed.  This can be particularly beneficial if you’ve built up substantial capital loss carry-forwards and also own a position with substantial capital gains. 

Act now! Remember, selling a security and buying it back is just one form of tax loss harvesting. Perhaps more frequently, tax loss harvesting involves netting the loss on one security against the gain in another.  Regardless of which version you use, you shouldn’t wait to start thinking about tax loss harvesting. You’ve got to think about it now, many weeks before the end of the year.  

Finally, keep in mind that with tax loss harvesting you are really making a tradeoff between future tax liabilities and present tax liabilities. Because it’s still unclear what changes widespread tax reform may bring, you’re likely better off acting on the certainty of today’s laws than betting on tomorrow’s.

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. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

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