Tax Loss Harvesting
By: Cameron Diehl, CFP®
Friends – The first half of 2022 was incredibly challenging for investors. Nearly every asset class experienced significant declines with the stock market entering a bear market. Even bonds, which typically serve to balance equity investments, lost value as interest rates rose rapidly. But there can be opportunity, even in the most difficult markets.
A common strategy I’ve mentioned in these notes over the years is the concept of tax-loss harvesting – intentionally realizing losses in your portfolio to save on taxes. After all, taxes are one of the most significant drags on investors’ net returns over their lifetimes, and we make every effort to help mitigate their impact. And while this is a strategy we use with clients routinely, in all types of market environments, we become particularly active during times of heightened volatility, which is why I wanted to share a bit more detail on the benefits and strategy involved.
- How to Harvest a Loss – The first step in the process is identifying investments that have declined in value to sell and “harvest” the loss for tax purposes. This most commonly includes stocks but given the rise in interest rates and accompanying decline in bond prices, fixed income investments may currently offer an opportunity to harvest losses as well. When doing so it is important to understand the cost basis of your investments and to review individual tax lots to ensure you’re identifying the best investments to sell. Note: Harvesting losses only applies to taxable accounts and not tax-advantaged accounts like 401(k)s, IRAs, 529s, etc.
- Offset Capital Gains – The primary benefit of tax loss harvesting is the ability to use losses to offset realized gains dollar-for-dollar elsewhere in your portfolio. For example, if you have $10,000 in long-term capital gains that can be taxed at a maximum rate of 23.8%, and you’re able to harvest $10,000 in losses to offset them, you can realize a potential tax savings of up to $2,380. The benefits can be even greater if you are able to offset short-term capital gains, which are taxed at your ordinary income tax rate up to 40.8%.
- Deduct Against Earned Income – Additionally, if you are able to offset all of the capital gains in your portfolio and still have losses leftover, you are able to use excess losses to offset up to $3,000 of ordinary income per year. With ordinary income potentially taxed at a top rate of 40.8% currently, this can save you another $1,224 annually.
- Carryforward to Future Years – To the extent you have unused losses leftover after offsetting all of your gains and up to $3,000 of ordinary income, you are able to carry them forward to use in future tax years for the same purposes.
- Avoid Wash Sales – One of the most important things to keep in mind when harvesting losses is to avoid the IRS’ wash sale rule. This rule basically states that if you acquire the same or substantially identical securities within a 30-day period before or after the sale, the realized losses are disallowed and the loss is added to your cost basis in the new security.
- Avoid Short-Term Gains – Another pitfall to avoid with loss harvesting and wash sales is to avoid unintentionally creating new short-term gains that will be taxed at an even higher rate than if you had done nothing at all. For example, an investor may buy a security after harvesting a loss, have it appreciate in the ensuing 30 days and then sell it to buy back the previous security and realize a short-term gain that is then taxed at their marginal income tax rate up to 40.8%.
- Be Strategic – Tax loss harvesting can provide significant benefits when implemented consistently and effectively over the life of your investments. It is important to not let any one strategy derail your broader financial plan for the sake of tax savings. In my practice we work with clients to thoughtfully harvest losses, checking for opportunities regularly throughout each year and using times of volatility to accelerate these efforts. But we always do so in the context of clients’ broader plans, pairing loss harvesting with opportunities to rebalance portfolios and put cash to work where appropriate. We also work extremely hard to maximize our clients’ tax efficiency, trying to avoid the need to offset taxes in the first place.
In the end, tax loss harvesting, the associated rules and implications for your broader investment strategy can be very complex. These are just a few of the related considerations and it is important to consult with a qualified professional if you’re unsure how to proceed. As always, please reach out if you have any questions at all. I’m happy to help.
Opinions expressed in the attached article are those of the author and are not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of Raymond James, we do not render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.
