Provided By Phil Behnen, CPA, CFE
Are there investments in your portfolio that have fallen in value since you purchased them? As we near the end of the year, it’s an opportune time to examine strategies that could help lower 2015’s tax burden. Tax-loss harvesting is one such method that many investors utilize to help reduce tax obligations.
Whether you want to hold the investment for the long term or realize any losses now, tax-loss harvesting may benefit your situation. Tax-loss harvesting is selling a security at a loss now to offset gains from other investments in the current tax year or possibly carry forward to future years. This strategy can help reduce an investor’s tax bill now and in the future.
Benefits of Tax-Loss Harvesting
Tax-loss harvesting is the practice of selling investments within a taxable account at a loss, thereby generating a capital loss that can be used against current capital gains and possibly against an investor’s future income. The ultimate objective is to limit the impact of capital gains taxes. Short-term capital gains, which are defined as gains on assets held less than one year, are normally taxed at a higher federal income tax rate than long-term capital gains.
When properly applied, a loss in the long-term capital value of Stock A could be sold to offset the reportable long-term gain in value of Stock B, thus reducing the capital gains tax liability of Stock B. Furthermore, once an investor has offset all of their long-term capital gains, they can offset the loss against other short-term capital gains. Not only can this reduce tax burden for investors, but it can also help diversify a portfolio in ways that may not have been considered. By recognizing a tax loss, investors have various options such as allocating their tax savings in a similar but different investment.
In addition to offsetting taxable gains, the IRS allows investors to take up to $3,000 of losses per year if married filing jointly ($1,500 if single) to reduce their ordinary taxable income. It’s important to note that tax-loss harvesting only applies to investment losses held within taxable accounts. Investments held within tax-advantaged accounts such as 401(k)s and Roth IRAs do not receive the same benefits. However, high-income earners that have maxed out their tax-advantaged accounts should be aware of tax-loss harvesting opportunities when managing their portfolios.
Rules and Regulations
In order to take a physician tax deduction on the loss, an investor must sell the investment and not purchase the same or substantially similar investment for at least 30 days before or after the sale date. The purchase of that asset or a substantially similar asset in that 60-day window will cause the loss to be disallowed by the IRS under the wash-sale rule, but may be able to be carried over and added to the cost basis of the new purchase. However, an investor does not need to wait to reinvest the same dollar amount in an asset that is not substantially similar.
If an investment has fallen in value but the long-term outlook is promising, there’s the option of claiming the loss and re-investing in the same security after 30 days. One possible risk is if the security appreciates in value during the 30 day period that funds are not invested. This consideration, among others, should be weighed against the perceived gains from realizing the loss.
Harvesting a loss every time there is a fluctuation in the market can be a burdensome task from a tax-preparation standpoint. Therefore, the transaction costs of buying and selling should be compared to the amount saved in taxes when harvesting a loss. The general idea is to realize the loss if the tax benefits outweigh the administrative costs and investment risk.
Tax-loss harvesting is an active portfolio management strategy that may allow investors to improve their after-tax returns in some cases. It won’t restore actual investing losses, but it can save money by helping to reduce the tax burden. Markets can be volatile and unpredictable, but tax-loss harvesting may aid investors in making a tactical exit from an under-performing security. Prior to taking action, make sure to consult with your tax professional about your specific situation to make an informed decision.
Advisory Services offered through Larson Financial Group, LLC, a Registered Investment Advisor. Securities offered through Larson Financial Securities, LLC, Member FINRA/SIPC. Tax services offered through MedTax Inc., an affiliated company. Tax loss harvesting is a complicated issue and cannot be fully covered within the context of this article. This article should not be construed as tax advice. Please contact a qualified tax professional with knowledge about your specific needs.
Larson Financial Group, LLC, Larson Financial Securities, LLC and their representatives do not provide tax advice or services. Please consult the appropriate professional regarding your tax planning needs.