Tax Loss Harvesting – Not Just at The End Of The Year
Most of the time we’d think about investments at end of the year. However, throughout the year, there may be volatility in the market which presents a perfect opportunity to take a peek at your portfolio for any tax losses to harvest!
Look at your portfolio’s unrealized capital gains in any taxable account you may have. Are there any positions in your portfolio that have a loss? If so, you can consider selling the ones that are underperforming so you can use that capital loss against capital gains. If you have multiple lots, meaning, multiple dates when you’ve purchased the position, you can specify to sell just the lots that have a loss.
Tax-loss harvesting generally works like this: Sell an investment that’s underperforming, reinvest that money into a different security that meets your investment strategy and lastly, use the loss to reduce your taxes. Tax loss harvesting is a great strategy to lower your tax liability. If you’ve been rebalancing throughout the year, you use that loss to reduce the taxable capital gains you may have already taken. Any additional losses could also offset up to $3,000 of your ordinary income per year. Furthermore, any unused capital loss after that is carried forward to future years, so it is a great way to use a loss in your portfolio from a downturn in the market to your advantage.
Just remember that there are wash sale rules. The rule is if you sell a stock for a loss, you are not allowed to buy a substantially identical security within 30 days before or after the date of the sale. Most of the time, investors sell the security at a loss and buy it back after 30 days. Alternatively, 30 days before you could double up on a position and sell half of it after 30 days, specifying the lot with the loss.
To avoid the wash sale, you can replace a stock with a different stock in the same industry, replace index funds with managed funds or replace an index fund with a mix of other index funds. A substantially identical security is if you replace an index fund with another identical index fund or sell a stock in one account and buy the same stock in a different account that you or your spouse hold.
If a wash sale does happen, the IRS will disallow the tax deduction. Instead, the amount of the loss is added to the cost basis of the new security.
When you’ve realized your capital loss, losses on your investments are first used to offset capital gains of the same type. Short-term losses (losses from assets held a year or less) are first deducted against short-term gains, and long-term losses (losses from assets held over a year) are deducted against long-term gains. Net losses of either type can then be deducted against the other kind of gain.
That works great if you have enough losses in your portfolio to offset all of your capital gains. However, if you’ve created both short- and long-term capital gains throughout the year but don’t have a lot of losses, keep your eye out for any short-term losses to offset the higher taxed short-term gains.
Should you use every loss you have? Probably not. You might want to have a threshold of how much loss is worth taking. Too small a loss could be erased by the fluctuation of the day’s trading. Also, keep in mind that each time you are selling, your portfolio may be out of balance for that 30-day period of time as well as potentially incurring trading costs.
The bottom line is that tax loss harvesting is just a strategy to help save on taxes. If you look at your portfolio all year round but especially during times of volatility, you might be able to take advantage of this strategy.