Contributed by: Robert Ingram, CFP®
In times of market volatility and uncertainty there are still financial strategies available as part of a sound long-term investment plan. One example to keep in the toolbelt can be the use of tax-loss harvesting. It’s when you sell a capital asset at a loss in order to reduce your tax liability.
While this sounds counter-intuitive, taking some measures to harvest losses strategically allows those losses to offset other realized capital gains. In addition, remaining excess losses can offset up to $3,000 of non-investment income, with remaining losses carrying over to the next tax year. This can go a long way in helping to reduce tax liability and improving your net (after tax) returns over time. So, how can this work?
Harvesting losses doesn’t necessarily mean you’re giving up on the position entirely. When you sell to harvest a loss you cannot make a purchase into that security within the 30 days prior to and after the sale. If you do, you are violating the wash sale rule and the loss is disallowed by the IRS. Despite these restrictions, there are several ways you can carry out a successful loss harvesting strategy.
Tax-Loss Harvesting Strategies
Sell the position and hold cash for 30 days before re-purchasing the position. The downside here is that you are out of the investment and give up potential returns (or losses) during the 30 day window.
Sell and immediately buy a position that is similar to maintain market exposure rather than sitting in cash for those 30 days. After the 30 day window is up you can sell the temporary holding and re-purchase your original investment.
Purchase the position more than 30 days before you try to harvest a loss. Then after the 30 day time window is up you can sell the originally owned block of shares at the loss. Being able to specifically identify a tax lot of the security to sell will open this option up to you.
Common Mistakes To Avoid When Harvesting
Don’t forget about reinvested dividends. They count. If you think you may employ this strategy and the position pays and reinvests a monthly dividend, you may want to consider having that dividend pay to cash and just reinvest it yourself when appropriate or you will violate the wash sale rule.
Purchasing a similar position and that position pays out a capital gain during the short time you own it.
Creating a gain when selling the fund you moved to temporarily that wipes out any loss you harvest. You want to make the loss you harvest meaningful or be comfortable holding the temporary position longer.
Buying the position in your IRA. This violates the wash sale rule. This is identified by social security numbers on your tax filing.
As with many specific investment and tax planning strategies, personal circumstances vary widely. It is critical to work with your tax professional and advisor to discuss more complicated strategies like this. If you have questions or if we can be a resource, please reach out!
Robert Ingram, CFP®, is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® With more than 15 years of industry experience, he is a trusted source for local media outlets and frequent contributor to The Center’s “Money Centered” blog.
The information contained in this blog does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Bob Ingram and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.