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Tax Loss Harvesting...Why?...How?

April 14, 2020

Why do we worry about paying too much income tax? For many, taxes are our largest expense!

It seems like there are two ways to approach tax-planning:

  1. Do nothing. Send in your numbers. Pay your tax
  2. Proactively plan. Try to get an edge on our tax system by using techniques that help you legally reduce your income tax liability.

Given tax planning is a vast topic with volumes of rules and regulations, our short summary of this topic is just to give you a heads up so you can dig deeper and become aware of tax-loss harvesting opportunities.

Tax-loss harvesting is the practice of selling investments for a loss. By realizing a tax loss, you are harvesting that loss to offset other tax liabilities. Tax-losses are only of value for taxable non-qualified accounts…not assets inside of retirement accounts.

Suppose you own XYZ Emerging Markets Fund with a cost basis of $50,000. The market falls…and XYZ now has a market value of $40,000. So…you sell it. You have realized a $10,000 tax loss. You have a couple of options of what to do with the $40,000 proceeds from the sale:

  1. Wait 30-days or more and buy back XYZ Emerging Market Fund. By waiting 30 days or more you avoid what the IRS calls a wash sale (see IRS Publication 550) to enable you to claim the tax loss.
  2. Buy a substantially different security with the sale proceeds. It would be best if the new security is a different asset class or a different fund manager. Thus, you are staying invested rather than being out of the market.

Either way, you have harvested a $10,000 tax loss that can be used do offset other realized capital gains or capital gain distributions. If you get to the end of the year and you have no other capital gain activity, you can deduct $3,000 (if married filing jointly; $1,500 if filing single) from your ordinary income and carry the unused tax-loss balance into the next tax year.

Many investors wait until the end of the year to look for tax-loss harvesting opportunities. We suggest looking for opportunities throughout the year to maximize tax- loss opportunities…especially during periods of volatile market activity.

We don’t believe that making investment decisions solely for tax reasons is the best strategy in most cases. The best investment results come from sticking to your long-term financial planning game plan!

The information above is not to be considered tax advice. Please coordinate all tax planning techniques with your tax professionals.

Contact us to discuss how this strategy fits into your overall financial plan.

* All calculations are hypothetical and are for illustrative purposes.