Tis the Season! Tax harvesting is a term that is frequently used around the end of the year. It can be used for both gains and losses. This is a tool we use to lock in gains or losses in a security before the year end. We accomplish this by selling securities.
One main reason we would harvest a gain before the end of the year would be if the client is aware they will need funds, but will be in a higher tax bracket next year, or has losses to offset it. This can be accomplished very simply, by selling the security. The security may be bought back at any time at a higher basis, while locking in the gain from the sale.
Harvesting losses is more common and can be done when a security or asset class has had a decline in value which is significant enough to overcome any trading costs associated with selling and buying back the investment. By selling after a decline in value, we are able to lock in the losses for tax purposes. Those tax losses can be used to directly offset capital gains in the same year, thus saving money on your tax bill. Any losses not used in the current year will carry forward to future years’ capital gains.
There can be some pitfalls with this strategy. One of which is called a wash sale. In order for the IRS to allow the benefit of your loss on an investment, they prohibit you from buying the same or substantially similar investments within 30 days of your sale. If you buy the security back within 30 days, it will trigger a wash sale which will disallow any losses on the position in the current year. Without going into too much detail, if you are planning on selling a security for loss purposes, wait 30 days to purchase it back. Secondly, before you sell something for the loss, you want to make sure it’s in a taxable account, since investments in tax sheltered accounts such as IRAs or Roths do not have any tax consequences. Lastly, you need to make sure you are comfortable being “out of the market” while you are waiting your 30 days to purchase back. These days the markets can move very quickly, and if you miss out on just a few major gaining days, the lost opportunity cost may be worth more than the tax loss offset.
Happy Tax Planning!