When it comes to their portfolio’s investors hate to take losses. But sometimes a loss could be just what the CPA ordered. As we wrap up another strong year in the stock market many people are starting to think about the tax consequences of all the gains that have realized in the past year. The good news is that with a few weeks left in the year there are still opportunities to make portfolio changes that could be beneficial from a taxation standpoint.
What is Tax-Loss Harvesting?
As the name implies Tax-Loss harvesting is the selling of securities at a loss to offset a capital gains tax obligation. With this strategy any realized losses can then be used as a credit against any gains that have been realized in the same calendar year. This strategy can only be used for taxable accounts, IRA’s are not eligible for tax-loss harvesting.
How Tax-Loss Harvesting works?
When looking for tax losses, focusing on short-term losses can provide the greatest benefit since they can be used to offset short-term gains which are taxed at your marginal tax rate and often higher than your long-term capital gain rate. Tax code dictates that short- and long-term losses must be first used to offset the same type of gain. Any excess may be than carried over to the other type. For example, if you sell a long-term investment for a loss of $25,000 and only had $15,000 in long term gains for the year the remaining $10,000 may then be applied to any short-term gains realized in the same year.
Example: If you were to sell several stocks with a combined long-term gain of $30,000, the full $30,000 would be subject to 15% or 20%* Long Term Capital Gains Tax Rate depending on your income. However, if you also sold some stocks for a combined long-term capital loss of $12,000 you would be able to reduce your total realized gains to $18,000. This means your taxable gains for the year would drop from $30,000 to $18,000, which should lead to some good tax savings.
| Long-Term Capital Gains Rate filing status and income: 2019 | ||
| Long-Term Capital Gains Rate | Single Tax Filers | Married Filing Jointly |
| 0% | $39,375 or less | $78,750 or less |
| 15% | $39,376 – $434,550 | $78,751 – $488,850 |
| 20%* | $434,551 or more | $488,851 or more |
* Net Investment Income Tax (NIIT), which is 3.8% could cause the capital gains rate to be as high as 23.8% for certain high-income earners
Another way to use tax-loss harvesting is to sell investments for a loss even if you don’t have capital gains for the year. Doing this would allow you to tax advantage of the capital loss tax deduction which states that you can apply a maximum of $3,000 a year in capital losses to offset ordinary income. Any unused loss can then be carried forward to use in future years.
If you choose to implement a tax loss harvesting strategy, you should be aware of the Wash-Sale Rule. The wash sale rule states that you can’t sell a security for a loss and purchase the same security or “substantially identical” security for a period of 30 days before and after the sale date. Violation of this rule will result in the taxpayer not being allowed to claim the loss.
All though tax-loss harvesting is commonly used tax planning technique you should speak with your CPA or tax advisor before implementing this strategy. You should also discuss your plans with your Client Advisor to make sure any portfolio changes implemented do not cause violations of the Wash-Sale Rule.
For more information on other year-end tax planning strategies please see 5 Year-End Tax Planning Strategies.