Tax Loss Harvesting

Tax Loss Harvesting

“I shall never use profanity except in discussing house rent and taxes.” – Mark Twain

Well “*#$%”, how do I minimize my tax bill? Harvesting capital losses can be one solution to minimizing current year taxes.

What is tax loss harvesting?

This portfolio management technique involves selling securities that are at a loss from purchase price, and reinvesting in a “like” security. Essentially, loss harvesting locks in a realized loss on the security which can offset realized gains, while maintaining your asset allocation with a purchase of a “like” security.

Full disclosure: the IRS disallows the loss if you sell a security and immediately buy back the same security within 30 days. This is called a wash sale.

What are the Pros?

  • Lower your taxes for the current year
  • Being able to control your tax picture from year to year
    • Taking gains in low gain or income years
    • Taking losses in high gain or income years
  • The first $3,000 of net capital losses can offset taxable income on your taxes
  • Taking advantage of after tax returns, which is what everyone should focus on!

What are the Cons?

  • Transaction fees
  • Relative performance from the “like” security
    • Like securities might not track each other very much. Think of Chevron and Exxon, both large integrated energy companies. However, YTD as of 12/14/2017, stock returns are 4.77% and -4.33%, respectively.
  • A lot of people harvest losses at the end of the year. Thus, security prices might be artificially low due to a lot of people hitting the sell button.
  • You might not get out of paying taxes. If you swap to a “like” security, and that “like” security increases in value, then you took your loss and have an unrealized gain in the “like” security.

Why does it make sense?

  • Working with a financial advisor, you can plan high tax and low tax years and be strategic about taking gains/losses
  • Deferring taxes is always a sound strategy in an otherwise diversified portfolio. In fact, if you never sell the security, when you pass away, that security gets “stepped up” and your beneficiaries get the security without the tax liability associated with it.

Zach Cole

Zach Cole is an analyst and trader at Colorado Financial Management. He is a CFA charterholder.

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