Tax Harvesting Essential Tips

Tax Harvesting: Everything You Need to Know

Can you profit from losing investments? Actually, yes. Seeing as the Tax Day 2020 deadline has been extended to July 15th, 2020, you still have time to minimize your owed taxes and profit from investment losses for the fiscal year. That is if you’ve sold off losing investment and know a thing or two about tax-loss harvesting.

Depending on the market situation, you’re going to undoubtedly experience capital gains and losses over time. While you always hope for gains, you have to pay taxes on the gains depending on your tax bracket thus reducing your overall profit. To offset any losses you might experience due to taxes, you can turn to tax-loss harvesting.

Here’s everything you need to know about tax harvesting in order to reduce tax burdens on you as an investor and ultimately protect and grow your long-term wealth.

What Is Tax Harvesting?

Tax harvesting is the practice of selling securities that are now worth less than the investor paid for them; this can include stocks, mutual funds, and exchange-traded funds. The purpose of tax harvesting is to use capital loss to offset taxes on both capital gains and income by minimizing the money that the investors owe. For example, if you realize a $10,000 capital gain on the sale of a mutual fund, but you also sell a fund that’s at a $10,000 loss, the loss will offset the gain.  This means that there won’t be any taxes due. In short, you’re trying to “harvest” a loss to your overall tax burden, which you can claim on your ordinary income taxes as well.

How To Make Lemonade Out of A “Lemon”

By tax-loss harvesting, you can make lemonade out of a lemon investment. This method is simple, and you’re able to buy a similar security to replace the one you’ve sold. The advantage of this method is that you’re capable of maintaining your position in the market with your new investment. However, there are guidelines you must follow.

A financial advisor will be able to sit down with you, whether that’s in an office or online, and take a look at your portfolio to assess the performance of your investments. During this process, you might look at which investments are performing well and which ones aren’t expected to increase by the end of the year. When you see which investments aren’t likely to increase, you can prepare to sell them off in order to qualify for benefits through a tax loss. Always be sure to consult your financial advisor to ensure any investment moves fall in line with your holistic financial plan.

Avoid the Wash-Sale

The wash-sale rule prevents individuals from selling a security at a loss and then buying a “substantially identical” stock or security within 30 days before or after the sale.  Securities that meet these criteria are not recognized as different enough to be considered separate investments, such as common stock from the same corporation.

Do I Benefit If There’s No Capital Gain?

Many people believe that they can’t make use of tax harvesting unless they earn capital gain, but that’s not the case.  If you don’t have any capital gain, you can use $3,000 of your realized capital loss to reduce your taxable income from that year.  Any additional loss will then be carried into future tax returns.

Example: Amy is a single income-tax filer. She originally purchased a stock for $8,000, but the stock is now worth $6,000.  If she sells her stock, she’ll have a loss of $2,000.  Since she doesn’t have any capital gains, she could use her loss of $2,000 to reduce her taxable income for the current year.  Let’s say that her marginal tax rate is 30%; this means she could receive an income tax benefit of up to $600 ($2,000 X 30% = $600).

Factors To Consider

If tax harvesting is an approach you are considering, make sure to keep in mind how long you’ve had your securities and what account you have them under.  This process only works in taxable investment accounts such as an individual account, joint account, or taxable trust accounts.  You can’t use your losses in conjunction with individual retirement accounts to offset any capital gains because these types of retirement accounts are not subject to taxation.

In regards to the length of time that you’ve held your security, there are two groups: short-term and long-term.  If you’ve had it for less than a year, it is a short-term gain or loss and will be taxed at the same rate as ordinary income. The rate is a maximum of 37%.

Long–term capital gains and losses, on the contrary, are securities that have been held longer than a year.  These are only taxed at a maximum rate of 20%.  Short-term losses will first offset any short-term gains, while long-term losses will first offset long-term gains.

When Should I Tax Harvest?

Tax harvesting can be helpful at any point in time, but especially now with flummoxing markets, while many people’s securities are dropping in value.  According to CNBC columnist Darla Mercado, “While selling out of the market altogether could hurt your long-term plans, getting rid of a few losers could ultimately improve your tax picture.”

If you’re wondering if this is a good option for you, reach out to your financial advisor. Together you can discuss if you can put the money to better use somewhere else.  If your stock was doing poorly before the pandemic even started, evaluate if your tax planning can be in the “green” even if your portfolio is in the red.  If your stock is only down because of the current circumstances but is most likely going to return to its original price, you probably want to keep your stock.

Tax-Harvesting Done Right

Before rushing for a tax write-off, make sure to carefully consider your options.  Although this is a great option for people that are losing money on their securities, it’s important to consider short-term and long-term benefits. As we’ve discussed, time in the market is always wiser than timing the market. Before making a concrete decision, discuss your financial goals and investment strategies with your advisor. A fiduciary financial advisor with experience in tax-loss harvesting is your best resource in strategizing how to make lemonade out of a lemon investment.

Disclosure: This blog is not investment advice and should not be relied on for such advice or as a substitute for consultation with professional accounting, tax, legal or financial advisors. The observations of industry trends should not be read as recommendations for stocks or sectors.