Hello everyone and welcome to this month’s Ask the CFP segment. This month’s question is, “What is tax loss harvesting?” Tax loss harvesting, which I’m going to call TLH at the risk of being tongue-tied throughout this video, is a special tax strategy whereby investments are intentionally sold at a loss for tax reasons. This type of strategy can be impactful especially during market downturns or periods of market volatility. So why would someone want to intentionally realize a loss on an investment when financial planners generally recommend holding investments long-term?
Let’s assume you own two stocks in a taxable investment account, such as a brokerage account. TLH doesn’t apply for retirement accounts such as IRAs or 401(k)s. Let’s also assume you invested $50,000 into each of these stocks or a total of $100,000. If one of your stocks does well and grows to $70,000, but your other stock does poorly and declines to $40,000, your portfolio is now worth $10,000 more at $110,000.
Now let’s assume you want to sell some of your gains in the larger stock to manage risk in your portfolio. Selling this stock at a gain means you will owe taxes on the gain. However, if you sell shares of your other stock, which is at a loss, the IRS generally allows you to offset investment gains with investment losses. Therefore, you may be able to harvest losses to offset gains and potentially avoid paying taxes on the gains. Keep in mind, not all investment losses can offset investment gains. To keep this simple, we’ll assume each stock has been held for over one year for a long-term capital gain or loss.
In the market drop of 2020 due to COVID, many people found their portfolios in decline. For those that had taxable non-qualified investment accounts with investments at a loss, it provided an opportunity to intentionally sell those investments to realize a tax loss to offset taxable gains in that tax year or future years. While selling at a loss may sound like selling while the market is down, keep in mind that TLH usually involves immediately buying a similar investment to remain invested. A simple example would be selling Pepsi at a loss and immediately buying Coke. You would still own a large, US beverage brand while taking advantage of a TLH opportunity.
One important rule to keep in mind with TLH is avoiding something called a wash sale. A wash sale disqualifies someone from being able to realize and deduct a tax loss when buying a substantially identical investment 30 days before or after the loss sale. In other words, the IRS rule is meant to avoid misuse of TLH by realizing a tax loss and then immediately buying the same investment back again. TLH may sound a bit complex and does require work, but when used properly, it can be a powerful tax strategy.
If you have a question about this topic or have a question for next month’s video, please send it to DTroyer@MonetaGroup.com. Thanks for watching and we’ll see you next month.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Please speak with a qualified tax or legal professional before making any changes to your personal situation.
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