Autumn is a time of harvest, filled with traditions celebrating abundance as folks reap the rewards of what’s been grown. But with many of our investments dropping in numbers vaster than the leaves falling from trees, it can be hard to feel grateful or bountiful right now.
Take heart, for there is a silver lining among the sparse foliage. Fall is also a good time to take advantage of a strategy called Tax Loss Harvesting.
Read on to learn how you might be able to lower your tax bill this quarter and better position your portfolio going forward.
Know the Lingo
Tax Harvesting
Deliberately selling an investment at a loss in order to offset taxes owed on an investment sold at a profit (stocks, bonds, ETFs, digital assets)
Realized Gain
When an investment is sold for a higher price than it was purchased
Realized Loss
When an investment is sold for a lower price than it was purchased
Wash Sale
When you sell a security (stocks, bonds, options) at a loss for the tax benefit but then turn around and buy the same or a similar security within 30 days. *It’s a good rule of thumb to wait 31 days before repurchase if you plan to do so
The Basics of Tax Loss Harvesting
We know this down market has been a queasy ride for many investors this year, but one way to turn that negative into a positive is a tactic called tax loss selling or “harvesting.” In a nutshell, this strategy aims to offset capital gains with realized losses. The goal? To ultimately reduce taxes owed to Uncle Sam on investments that made money this year.
Let us explain.
At this point in the year, most people have investments that haven’t performed well and are worth less than their cost basis, which when sold creates a loss.
When you sell an investment asset for a profit, you owe capital gains taxes on the profits based on how long you held that investment. Selling an asset when you’ve owned it for less than a year (short term) will result in different tax consequences than if you held that asset for more than one year (long term) before you sold it.
Since investments sold for a gain are taxed but ones sold at a loss are not, incurring losses lowers your overall amount of gains, with the potential of shrinking your tax bill.
Keep in mind this can only be done in our taxable accounts (think non-registered accounts like individual, joint, trust accounts, etc.), not in retirement accounts where we aren’t paying taxes on activity that occurs inside the account itself.
Let’s say you invest $50,000 in a taxable asset and it falls to $40,000…You could sell it and harvest the $10,000 loss by claiming it against other taxable gains. In some cases, you may even be able to claim the loss against a portion of your ordinary income, for further tax breaks. We won’t overwhelm you with all the tax laws here, that’s a conversation to have with your accountant – we just want to make you aware that there might be opportunities within your portfolio to soften the blow of 2022’s volatility.
How and When to Harvest
Tax loss selling can be done at any time, but down markets offer even greater opportunities to realize losses and use those proceeds to purchase other positions at hopefully bargain prices. These new investments could potentially enhance your portfolio performance as the market recovers.
Here at TradeWinds, we continually keep a pulse on where our clients stand with realized gains and losses – it’s something we look at throughout the year, but in the 4th quarter, we actively do a deeper dive to see if there are any positions currently at a loss, so we can sell those, capture that loss and use it to offset the gains.
The time to harvest your losses is now, during pumpkin season and sweater weather –remember, it must be done before year-end. Not sure if your portfolio can benefit from a rebalance? Talk to your financial advisor or reach out to your tax pro for guidance. The rules are specific and complicated – tax loss harvesting is not something you want to do on your own.
Learn More
Got the basics down and want to know more? Here are some good resources:
Wishing you and yours a bountiful Thanksgiving, We are incredibly thankful for all of our clients and readers!
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