Understanding Tax Loss Harvesting

Friday, 05 August 2022

What is Tax Loss Harvesting?

When investments in taxable accounts do not perform as hoped and actually lose value, investors may be able to take advantage of tax benefits to help offset their losses. The concept of tax loss harvesting is fairly straightforward. It involves identifying investments that have lost value and selling them in order to generate capital losses. Then, investors can use those losses to offset capital gains realized by other investments during the tax year, thereby seeking to lower the amount ultimately owed to the IRS.[i] The amount of potential tax savings an investor might realize will depend on their tax bracket and whether they are trying to offset short-term or long-term capital gains. Short-term losses may be used to offset short-term gains and long-term gains can be offset by long-term losses. If you have more capital losses than capital gains, you can use up to $3,000 in losses to offset other income.[ii] Capital losses that exceed this amount may be eligible to be carried forward to future tax years.[iii]

When Should Investors Consider Harvesting Tax Losses?

Many high-net worth investors focus on tax loss harvesting at the end of the year, as they begin preparing for their tax bills due the following April. However, you can actually harvest tax losses on investments at any time during the year. There may be valid reasons to identify losing investments and remove them from your portfolio earlier in the year. Waiting until late in the year and selling your losing investments at the same time as everyone else could actually end up costing you money. That’s because investors looking for bargain stocks understand tax loss harvesting and are incentivized to wait until selling activity reaches its peak – so they can pay as little as possible for their acquisitions.[iv] Unlike some tax strategies which allow you to make tax-advantaged moves until the federal April 15^th tax filing deadline, if you are going to take advantage of tax loss harvesting, you only have until December 31 each year to do so.[v]

What is the “Wash Sale Rule”?

Investors may not deduct a capital loss against a capital gain for the same or a substantially-identical security.[vi] Investors who want to take advantage of tax loss harvesting must be mindful of the IRS “wash sale rule.” Under this rule, an investor may not take advantage of capital losses incurred by selling an investment when the investor replaces it with a “substantially identical” investment within 30 days before or after the sale.[vii] While it sounds simple, the wash sale rule can be complex to navigate – especially for investors with diversified portfolios. The rule can be triggered and losses disallowed inadvertently if your spouse or a company you control purchases the same or a substantially-identical investment within 30 days from when you sell it. The rule can even be triggered if the security is purchased in a non-taxable account within 30 days of selling it in a taxable account.[viii] If you are considering tax loss harvesting in your portfolio, work with your financial professional who can help you make informed decisions while being mindful of compliance with the wash sale rule.

Important Disclosures:

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

The information provided is not intended to be a substitute for specific individualized tax planning or legal advice. We suggest that you consult with a qualified tax or legal advisor.

All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.

[i] https://www.fool.com/knowledge-center/what-is-tax-loss-harvesting.aspx

[ii] https://www.forbes.com/sites/davidrae/2021/12/30/how-to-lower-your-2020-taxes-with-tax-loss-harvesting/?sh=2191ed3c1a93

[iii] https://www.irs.gov/taxtopics/tc409

[iv] https://www.fool.com/taxes/2019/10/13/harvesting-tax-losses-dont-delay-or-itll-cost-you.aspx

[v] https://www.nerdwallet.com/article/taxes/tax-loss-harvesting

[vi] https://www.investopedia.com/articles/taxes/08/tax-loss-harvesting.asp

[vii] https://www.forbes.com/sites/forbesfinancecouncil/2021/12/28/the-pitfalls-of-tax-loss-harvesting/?sh=66e4a8717009

[viii] https://www.investopedia.com/articles/retirement/09/ira-wash-sale-rule.asp

Sources

https://www.fool.com/knowledge-center/what-is-tax-loss-harvesting.aspx

https://www.forbes.com/sites/forbesfinancecouncil/2021/12/28/the-pitfalls-of-tax-loss-harvesting/?sh=66e4a8717009