The last few months have definitely been challenging and interesting on many different levels from a stock market perspective. A silver lining in the recent market volatility that many people do not often take advantage of is tax-loss harvesting. What is tax-loss harvesting?
Tax-loss harvesting is where you realize losses in the portfolio with the intention of offsetting realized gains now or in the future to help reduce future tax bills. This works through selling an investment that has underperformed and is losing money and changing to another investment that becomes a tax-winner. Drawdowns in the market, as we saw in February and March, can provide a significant amount of loss that may be harvested.
Many investors wait until year end to attempt tax-loss harvesting, especially in a year like 2019, where we saw very little volatility. However, this year offers an opportunity to capture losses that we haven’t seen since 2008 and 2009.
An investment loss can be used for 2 different scenarios:
1. The losses can be used to offset investment gains either today or in the future. Short-term losses can be used to offset short-term gains, and long-term losses can be used to offset long-term gains. The least effective use of short-term losses is to apply them to long-term gains, but may still be preferable to paying long-term capital gains tax.
2. The losses can help offset $3,000 of income on a joint tax return in one year. Unused losses can be carried forward indefinitely.
When performing tax-loss harvesting, one has to be aware of the wash-sale rule. The wash-sale rule states that if you sell a security, fund or ETF at a loss and buy the same or substantially identical security within 30 days after the sale, the loss will be disallowed for tax purposes. For example, if you own IVV, iShares Core S&P 500 ETF and sell it for a loss, and then purchase SPY, SPDR S&P 500 ETF with the proceeds, the IRS will most likely deem this to be a wash sale violation and, therefore, not be able to take advantage of the realized loss.
Tax-loss harvesting and portfolio rebalancing can provide nice synergies as they play different roles in portfolio management. When we rebalance a portfolio, we are managing risk in the portfolio, by selling holdings that have outsized their target holdings and adding those gains to positions that may have losses or not grown as much. Often in rebalancing, the portfolio will experience sizable capital gains. That’s where tax-loss harvesting helps reduce the gains and bring the risk of the portfolio back to its target allocation.
We will continue to monitor the portfolios and look for opportunities to tax-loss harvest in the future, not just at year-end, but year round.
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