Typically, harvests happen seasonally. Strawberries ripen in the spring, corn is eye high by the Fourth of July, those grapes get stomped in the fall, and chestnuts roast on winter fires.
Tax-loss harvesting is different. Those who are familiar with the strategy tend to mistakenly assume that losses are best harvested at year-end, when taxes are top of mind. In reality, tax-loss harvests can happen whenever market conditions and your best interests warrant it.
What is tax-loss harvesting?
When properly applied, tax-loss harvesting is the equivalent of turning your financial lemons into lemonade by converting market downturns (whenever they may occur) into tangible tax savings. A successful tax-loss harvest lowers your tax bill, without substantially altering or impacting your long-term investment outcomes.
How does it work?
If you sell all or part of a position in your taxable account when it is worth less than you paid for it, this generates a realized capital loss. You can use that loss to offset capital gains and other income in the year you realize it, or you can carry it forward into future years. (There are quite a few caveats on how to report losses, gains and other income. A tax professional should be consulted, but that’s the general premise.)
Here’s a three-step summary of the round trip typically involved:
- Sell all or part of a position in your portfolio when it is worth less than you paid for it.
- Reinvest the proceeds in a similar (not “substantially identical”) position.
- Return the proceeds to the original position no sooner than 31 days later (after the IRS’s “wash sale rule” period has passed).
Again, once the dust has settled, our goal is to have generated a substantive capital loss to report on your tax returns, without dramatically altering your market positions during or after the event.
Remember, tax-loss harvests should occur when market conditions allow for them AND when your best interests warrant it. There are several reasons that not every available loss should be harvested. To name a few:
Costs – The potential tax savings may not offset the trading costs involved. Before the harvest, do the math.
Tax planning – A tax-loss harvest can reduce your taxes in the short-term, but may generate higher capital gains taxes later on (by lowering the basis of your holdings). Loss harvests should be managed in concert with your larger tax planning projections.
Asset location – Holdings in your tax-sheltered accounts (such as your IRA) don’t generate taxable gains or realized losses when sold, so they aren’t available to harvest.
It’s never fun to endure market downturns, but they are an inherent part of nearly every investor’s journey toward accumulating new wealth. When they occur, we can sometimes soften the sting by leveraging losses to your advantage. That’s why we keep a year-round eye on our clients’ holdings, so we can be ready to spring into action any time a harvesting opportunity may be ripe for the picking.
Let us know if we can ever answer any questions about this or other tax-planning strategies you may have in mind.