Seasons change and so do market conditions. Springtime is rarely associated with harvests, but unfortunately this spring it has been a prevalent term around the Bartlett office. Specifically, tax loss harvesting. By its definition, it’s not a fun topic. You are selling a security worth less than when you bought it, which is never the goal of an investment. However, we recognize the importance of seeking opportunities that add value for our clients.  Equity markets historically offer a nice return for investors willing to take on the risk. Yet, that return can be choppy during periods of uncertainty. As much as our advisors believe in the long-term investment approach, strategically selling assets at losses in taxable investment accounts can be advantageous for clients.

Given we’re talking about a tax strategy, it’s rarely as straightforward as one would hope. Yet the intention behind the strategy is simple – minimizing our clients’ taxes. The intention of this article is simple too – lifting the veil on tax loss harvesting.

The Basics

More often, when an asset is purchased, it grows in value, and taxes must be paid on the gain at time of sale. You can sell a position that has lost value to offset some of those gains. Any realized long-term losses (positions held for more than 1 year) will first be used to offset long-term gains. If you still have losses after offsetting gains, additional harvested losses will be used to offset short term (less than 1 year) capital gains. Lastly, they can be used to offset income up to $3,000 in a calendar year. If there are still losses remaining, you can carry the remainder forward for the next year you may have gains. And the loss can be carried forward until depleted – no limit on the years.

Let’s look at an example of this strategy in action: You bought a stock in 2020 for $40,000. As time progresses, it doesn’t perform as you had hoped and by the time you decide to sell, its value has dropped to $30,000. While a $10,000 loss isn’t ideal, it opens the door to some strategic financial planning options. Here’s how – since you’ve realized $5,000 in long-term gains and $1,000 in short-term gains on other positions sold, your loss of $10,000 offsets the $6,000 of gains, meaning no taxes are owed.

Of the remaining $4,000, $3,000 can be applied to reduce your overall taxable income for the year. The final $1,000 can be carried over into future tax years, ready to offset gains or reduce taxable income down the line.

What seemed like a setback in the beginning turns into an advantageous tax strategy, illustrating how losses can play a bigger role in your long-term financial plan.

 Common Concerns and Questions

I still like the stock. No problem. Our advisors routinely incorporate this strategy with positions we continue to like. There is a 30-day wash sale rule (asset cannot be repurchased for 30 days to lock in loss on position). Once we get beyond the 30 days, the asset can be repurchased. For the intervening 30 days, an asset with similar exposure (think selling Coke, buying Pepsi stock) can be purchased as a placeholder so the proceeds remain invested and can reap the benefits if the market rebounds.

Can I use long term losses to offset taxable income? Yes, you can. Long-term losses can offset taxable income up to $3,000 in a given tax year.

Can I carry forward both long and short-term losses? Yes, both long-term and short-term losses can be carried forward to offset future gains or income.  

Is there any benefit to making such trades in a retirement account? No. Given they are tax sheltered, this would provide no benefit in either traditional or Roth retirement accounts.

Can I sell the asset for a loss in my taxable account and repurchase in my non-taxable/retirement account? No, the wash sale rule applies to all assets owned by an individual (or married couple if filing jointly).

Does this apply to only individual stocks/securities or can I tax loss harvest ETFs and Mutual Funds as well? Yes, all assets within the taxable account can be harvested if basis is underwater.

IMPORTANT NOTE: You cannot sell an asset and purchase one that is considered “substantially identical”. According to the IRS, this refers to assets with 70% or more overlap in their holdings. For example, selling one fund that tracks the performance of the S&P 500 index and buying another fund tracking the same index would violate the rule.

In conclusion, tax loss harvesting is a powerful tool for managing your portfolio’s tax liability, with both immediate and long-term benefits. By realizing losses, you can offset gains, reduce taxable income, and carry forward losses to future years – all while maintaining similar market exposure.

DISCLOSURE
This material provided by Bartlett Wealth Management (“Bartlett”) is for informational purposes only and is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product. Nothing in these materials is intended to serve as personalized tax and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances. Opinions expressed by Bartlett are based on economic or market conditions at the time this material was written; actual economic or market events may turn out differently than anticipated. Facts presented have been obtained from sources believed to be reliable. Bartlett, however, cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source.

Tax loss harvesting involves certain risks and may not be suitable for all investors. The tax benefits of tax loss harvesting depend on individual circumstances and are subject to change. It is important to understand the wash sale rule and consult with a tax advisor before implementing a tax loss harvesting strategy. While tax loss harvesting can help offset capital gains and potentially reduce your tax liability, there is no guarantee of specific tax outcomes.