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What is tax loss harvesting? 
We usually talk to clients about two things we want to make certain of: not selling when stocks go down and not having to change their lifestyle when we are in a down market or a recession. Tax loss harvesting fits into this because immediately after we sell the positions to realize the loss, we purchase another very similar but not identical security – so that we stay invested. We offset the sale by a purchase so that we stay invested. We are not getting out of the market.
We usually want to stay invested during down markets. Why? Because timing the market is nearly impossible. Even if you get out of the market at the highs, you will probably miss the lows to jump back in. If you invested in a hypothetical S&P500 fund 20 years ago and missed the first 10 days of each market rebound, you would've forfeited more than half your gains (vs. just holding).
So, what is tax loss harvesting?
In layman’s terms, tax loss harvesting allows you to stay invested during down markets so that you can ride the market back up while taking a loss on a position that you can write off on your taxes. This will either increase your tax refund or reduce what you owe at tax time.
You are allowed to deduct realized losses of $3,000 per tax year. Anything over that can roll over to the next year and it can be used indefinitely in the future to offset future realized gains.
For example, if you are in the 32% tax bracket, deducting $3,000 would save you about $960 (32% * 3,000).
This costs you nothing if you’re working with us. It’s part of what we provide because it helps increase your overall return and that is what we want, too.
We report this on your tax documents and you or your CPA files it accordingly.
Sometimes, after 31 days, we will go back into the portfolio and “reverse” tax loss harvest so that we re-purchase the original securities. This makes sense depending on the unrealized gain or loss amount, the overall portfolio size, allocation, and strategy.
We are not allowed to deduct the loss if the same security sold, or “substantially identical” investment, is purchased 30 days before or after the sale. Therefore, we usually purchase another holding that tracks a different index but is still highly correlated to the original holding.
Is tax loss harvesting for you?
That depends.
The strategy isn’t necessary inside Roth or Traditional IRAs, only taxable accounts.
It might not be worth it if:
- The loss is very small
- Your tax bracket is low enough
- You already have more losses than you will ever use
- Your transaction costs are too high
What about tax gain harvesting?
This is a unique strategy where you sell off gains if (1) they can be offset against already realized losses or (2) if you are in a lower capital gains tax bracket than you will be in the future. This is especially true if you are in the 0% capital gains tax bracket. You can fill up that bracket with gains, pay zero tax, and have a higher cost basis. You purchase something similar for 31 days and then repurchase the original holding at a higher cost basis. The higher cost basis ensures lower taxes in the future. In other words, this allows your tax liability to become more certain and lower.
Tax loss harvesting is done on an ongoing basis and as needed in client portfolios. During down markets, the opportunity is more widespread among client portfolios.
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