Considering Tax Loss Harvesting? What You Need to Know First

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Kevin Oleszewski, CFP® Senior Wealth Planner

As the tax year draws to a close, many high-income investors will look to reposition their portfolios to intentionally generate losses as a way to offset gains — an investment strategy known as tax loss harvesting.

The goal? A net neutral tax position.

What Is Tax Loss Harvesting?

I sort of think of tax loss harvesting as the eharmony of investment planning. At its core, it’s about matchmaking and there are three core steps to making it all work:

  • Step 1: You identify equities in your taxable accounts — stocks, mutual funds, bonds, as examples — that aren’t performing well.
  • Step two: You single out those equities that have likely appreciated as much as they’re going to, producing a gain that you’re happy with.
  • Step three: You match up the loss and the gain — selling one investment at a loss to offset the capital gain generated by the sale of the investment you sold at a profit.

How Tax Loss Harvesting Works

Here’s an example of how a high-income investor might put tax loss harvesting to work:

Mrs. Investor buys 1,000 shares of XYZ stock at $100 a share. XYZ is now selling at $50 a share. In play: the sale of Mrs. Investor’s business later in the year for a gain of $500,000. What does she do? She sells the shares in XYZ stock at a loss of $500,000 to offset the gain from the sale of her business.

If it sounds a bit complicated, it is — and I wouldn’t recommend repositioning your portfolio like this without involving your tax advisor and financial planner.

There are many, many moving parts. For example, while a lot of people do tax loss harvesting at the end of the year, it can be done year-round. If there’s a big dip in the market or a lot of volatility, this is a strategy that could be employed to an investor’s advantage.

Who Can Benefit from Tax-Loss Harvesting?

It’s worth noting that tax loss harvesting isn’t for everyone. People in lower tax brackets (10% and 12%) are taxed at ordinary income rates when they sell a stock they’ve held for at least one year and a day. So, their capital gain is actually zero.

Who should consider tax loss harvesting? Investors in a tax bracket of 22% and up.

If you think tax loss harvesting could be a good fit, the first thing you need to do is establish the cost basis of your investment — in other words, what you originally paid for it.

Next, give your portfolio a hard look and think about the long-term effect of holding a particular investment. Everybody has an affinity for certain stocks.  My wife holds a stock that she will never ever sell, just because she loves that particular company so much.

Tax Loss Harvesting Top Considerations

There’s no way around it: Emotion can be involved here — and shouldn’t be. My advice? Your selection of investments to sell should be based specifically on tax loss harvesting reasoning — and not on anything else. You are looking at what has appreciated significantly or depreciated significantly. It’s as simple as that.

And when you replace the asset you’ve sold, it’s generally a good practice to seek out something that will give you the same type of exposure in your portfolio so that your asset allocation remains unchanged. For example, if you sell stock in a particular soda company, a well‐known telecommunications company, or a popular technology company, you might consider looking at their competitors.

Finally, keep this one important rule in mind: If, for example, you sell stock at a loss for tax purposes, you must wait 31 days to buy it again for it to still count as a loss. Anything short of that, and you will lose the deduction.

Have More Questions About Tax Loss Harvesting?

Talk to a qualified financial advisor to help you evaluate whether tax loss harvesting could be beneficial for you. If you don’t already have an advisor you can trust, give us a call. We’ll help you find someone who will put your needs first.

Kevin Oleszewski is not affiliated with Cetera Advisor Networks, LLC.

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