As market volatility has picked up this year and you have likely experienced sticker shock when reviewing your recent monthly investment performance, there may be a tax strategy called tax-loss harvesting to help soften the blow. Tax-loss harvesting is a strategy that can help reduce or offset capital gains either this year or in future years which can reduce your tax liabilities.
How do you harvest losses?
The concept of harvesting investment losses is no different than farmers harvesting their crops. You are “picking” losses in your portfolio to sell thus realizing this loss for tax purposes. Once you harvest all the losses you can use this basket of losses to offset capital gains this year or in the future.
Why would you want to harvest losses?
The main reason to harvest losses is to potentially reduce your tax liability now and possibly in the future. Investors that consistently harvest losses can build a piggybank of these losses that can be carried forward indefinitely to offset gains in future years. If an investor is in the top tax bracket in 2018 the maximum capital gain impact is a total of 23.8%. If you hit it big with some stocks earlier this year and sold to capture that gain then harvesting other losses could have a big impact on your tax liability. Every dollar of gain that you can offset with losses potentially saves you 23.8 cents in taxes.
What considerations should you make before you harvest?
Reinvestment of the sale proceeds – When you harvest a loss you must consider whether or not you still wish to own that investment in the future. The tax code says you are not able to reinvest these proceeds in the same or a substantially identical security for 31 days or your loss is disallowed. You can keep the proceeds in a cash account for 31 days then buy the stock back or use the proceeds to invest in an investment that may experience similar performance over the 31 days. Once you hit the 31st day you could sell this investment and invest the proceeds back in the original investment.
Trading costs – Your costs of trading should be factored in to determine overall tax benefit. If you have a slight loss on an investment and it costs more to sell then buy back you would recognize no benefit from the transaction.
You may be able to reap substantial tax benefits from a well-designed harvesting strategy. It is recommended that you seek advice from an advisor who understands both your tax situation and your investment strategy. Remember sometimes your best harvests will come in bad market years.
David P. Stone CPA, CFP® is co-founder of Tartan Wealth Management, a full-service wealth advisory firm offering both investment management and tax planning services.
All investing involves risk and no investment strategy can guarantee a profit or protect against loss, including the potential loss of principal. None of the information in this document should be considered as tax advice. You should consult your tax advisor for information concerning your individual situation. Tax Services are not offered through, or supervised by, The Lincoln Investment Companies.