The White House released an outline for major tax reform in September. There are some ambitious goals in the plan: reduce seven individual tax brackets down to three, lower the corporate tax rate by 15%, eliminate the estate tax, nearly double the standard deduction while eliminating most itemized deductions, and much more.
There could be some major changes ahead. But since so much remains up in the air as Congress debates the issue and actually writes the new law, it may not be worth diving into the details just yet. Instead, we’ll focus on a tax issue that is fast approaching for many investors: tax loss harvesting in preparation for your next tax filing.
“Tax Loss Harvesting” Defined
Tax loss harvesting is a method of using losses in your portfolio to offset gains.2 For simplicity and as an example, let’s assume that an investment portfolio is comprised of only stocks and bonds. As those securities fluctuate in value, an investor may choose to sell them for a variety of reasons (to rebalance the portfolio, to take profits, to exit the position for fundamental reasons, etc…).1
Come tax time, investors are responsible for paying capital gains taxes on any realized gains, unless they can potentially ‘offset’ those realized gains with realized losses. But the benefits of tax loss harvesting can go even further: if your capital losses exceed your capital gains in a given year, you can use the losses to reduce your ordinary taxable income by up to $3,000 (for married persons filing separately, the annual net capital loss deduction limit is only $1,500). What’s more, any losses ‘left over’ can be used in future years, without expiration during your lifetime—up to the yearly limits.
Let’s look at a hypothetical tax loss harvesting example to show how tax loss harvesting can work.
Let’s say in 2017 you sold shares of stock for $10,000 more than your purchase price two years ago. That gives you a $10,000 capital gain, on which you would owe taxes. However, let’s say you have another position in the portfolio valued at $15,000 less than what you bought it for, giving you a $15,000 capital loss. Since losses can offset gains, you could effectively wipe out your tax liability and have $5,000 in losses left-over to make up for some of your ordinary income (you can use up to $3,000 in the current year, with $2,000 left to potentially use the following year).2
4 Important Things to Know about Tax Loss Harvesting
Before you start selling securities in your portfolio for gains and losses, here are four factors to consider:
- Tax-loss harvesting can only be used in taxable accounts, not in retirement accounts or tax-deferred accounts like IRAs or 401(k)s.
- There are rules/restrictions regarding how one can use gains to offset losses. Generally speaking:
- A long-term loss (from the sale of a security held more than a year) would first apply to a long-term gain.
- A short-term loss (held less than one year) would apply to a short-term gain.
- If there are excess losses in one category (long or short), they can then apply to either type of gain.
- You must follow the “wash sale rule” when tax loss harvesting, meaning that if you sell a security at a loss, you cannot buy the same or “substantially identical” security within 30 days before or after the sale.2
- Lastly, remember that while taxes are important, they should not necessarily be the only driver of your investment decisions. First and foremost, investors should consider how trading in the portfolio may impact your investment goals, asset allocation, and investment performance.
Ask WrapManager About Tax Loss Harvesting in Your Portfolio
At WrapManager, though we are not tax professionals, we can help you harvest losses to offset gains near the end of every year. If you are not currently a client but are interested in strategic wealth management, we can review your portfolio for gains and losses – just reach out to us at 1-800-541-7774, or send us an email to email@example.com.
The information presented by WrapManager, Inc. is general information only and does not represent tax or legal advice either express or implied. You are encouraged to seek professional tax advice for income tax questions and assistance. WrapManager, Inc. does not advise on any income tax requirements or issues.