Are you thinking strategically about how to make your investments more tax efficient?
As we approach the end of the year, our team is busy reviewing client portfolios to look for opportunities to capture losses potentially lower client’s tax burden for the current year. This is a concept called Tax Loss Harvesting.
What is Tax Loss Harvesting?
Tax loss harvesting is a strategy used by investors to minimize their taxes by selling investments at a loss in their non-retirement accounts. This loss can offset gains from other investments that you have sold for a gain. The primary goal is to lower your overall tax liability while maintaining your investment strategy. Tax loss harvesting is primarily used to reduce capital gains taxes – not income taxes.
How It Works
When you sell an investment at a loss, you can use that loss to offset gains from other investments. For example, if you have $5,000 in gains from one stock and a $3,000 loss from another, your net taxable gain would be $2,000.
Steps we take to Implement Tax Loss Harvesting:
- 1. Identify Losing Investments: We review your portfolio to identify investments that are currently worth less than what you paid for them.
- 2. Consult with your Tax Preparer – We do not provide tax advice. So, before making any final decisions regarding tax loss harvesting, we like to communicate with our clients’ tax preparers to get their thoughts on any potential moves.
- 3. Sell the Losing Investments: If we (the client, the client’s tax preparer, and our team) are all in agreement on capturing the discussed losses, we would move forward by executing the sale of these investments to realize the losses.
- 4. Replace the Investments: To maintain your portfolio's structure, we can consider purchasing a similar investment. We must be mindful of the IRS's wash-sale rule, which disallows the deduction if you buy the same or a "substantially identical" security within 30 days.
Benefits of Tax Loss Harvesting
- Reduce Tax Liability: By offsetting gains with losses, you can reduce the amount of taxes owed.
- Future Gains: Harvested losses that aren’t used to offset realized gains can be carried forward indefinitely to offset gains in future years.
- Outside Assets: Harvested losses can be used to offset capital gains from assets outside of your investment accounts, such as real estate or business interests.
Considerations and Risks
- Wash-Sale Rule: Ensure compliance with the wash-sale rule to avoid disallowed losses.
- Market Timing: Be cautious of market timing risks when re-entering similar investments.
- Long-Term Strategy: Tax loss harvesting should complement your long-term investment strategy, not drive it.
Conclusion
Tax loss harvesting is a powerful tool for managing your investment portfolio's tax efficiency. By strategically realizing losses, you can reduce your tax liability while keeping your investment strategy on track. We always suggest consulting with a tax professional to tailor this strategy to your specific financial and tax situation.
Tax-loss harvesting involves certain risks, including, among others, the risk that the new investment could have higher costs than the original investment and could introduce portfolio tracking error into your accounts. There may also be unintended tax implications. Changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of Raymond James, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.
