How to Turn Your Investment Loss Into a Tax Gain
Seeing losses in your portfolio during market volatility may be disheartening. Utilizing those losses through a process called tax loss harvesting affords the opportunity to have your taxes benefit from those losses. Rather than selling stock due to inferior performance and shifting the allocations in your portfolio, you can lock in those losses while keeping your portfolio performance the same.
What is tax loss harvesting? Why should I utilize it?
Tax loss harvesting is when you realize, or “lock in,” the losses of your investments by selling the investment. Say you bought stock A at $150 per share, and that investment is now valued at $120 per share (or a $30 per share unrealized loss). You may lock in the loss of an investment by selling some or all of your shares. This is known as “realizing” your losses.
You can then use these losses to lower your tax bill in three ways:
Offsetting your realized gains from other investments sold
Offsetting capital gains generated from other activities such as a home sale, business sale, or collectibles
Offsetting up to $3,000 of your ordinary income
Tax loss harvesting is typically recommended for clients whose tax liabilities require year-round attention. We implement tax loss when positions we manage to hit a certain loss percentage. Toward the end of the year, we perform "tax-gain harvesting" where we look to sell positions with very high gains to ensure we are not generating a net gain for clients.
The “Wash Sale” Rule that minimizes loopholes
Unfortunately, you are not allowed to sell a stock and immediately repurchase it to recognize the losses. If you decide to sell an investment position at a loss, you may not purchase that same investment or a “substantially identical” investment 30 days before or after the sale at a loss. This is to avoid a “wash sale” rule violation. This rule applies to all investment accounts associated with your household and on your tax returns. If a wash sale rule violation happens, the IRS will not allow you to use the loss to offset your gains. The cost basis of your investment will also change as the disallowed loss is added to the cost basis of the new, "substantially identical" investment you purchased. Click here for more information on the wash sale rule.
Will I miss out on my investment returns by doing this?
While there is no guarantee that the original investment sold to harvest losses will stay valued at or lower than the price you sold it for, you can buy similar positions to maintain the allocation and expected rate of return in your investment portfolio.
For example, you sell your Apple stock (AAPL) and are looking for a replacement, so you decide to use a large-cap growth index fund. Large-cap growth index funds are funds that invest in various stocks/companies that are classified as "large-cap," meaning they are valued at a market capitalization of $10+ billion. The growth piece implies that the fund managers see that the companies offer strong earnings growth and are undervalued in the stock market. Using a large-cap growth index fund gives your portfolio continued exposure to the large-cap growth sector of the market during the time period you are not allowed to buy AAPL stock.
See tax loss harvesting in action.
Say you bought some AAPL stock at $10,000, and the stock is now valued at $7,500. If you were to decide to sell it, you would then realize a loss of $2,500. Then, you have another stock, MSFT, that you bought for $5,000 and is now valued at $9,000. You sell that stock and realize a gain of $4,000. Since you can use the losses generated to offset your gains, you would have a net $1,500 of capital gains to pay taxes on, rather than the original $4,000!
Human Investing is here to help.
Tax loss harvesting is done as part of our portfolio management services. We also offer tax planning as a part of our services, helping to ensure you receive comprehensive financial planning where you need it most. If you are interested, please reach out to us at 503-905-3100 or hi@humaninvesting.com.