By: Kate Hennessy
Tax loss harvesting is the practice of selling an asset in your taxable investment account that has experienced a loss and replacing it with a similar asset to maintain the overall allocation within your portfolio. By realizing, or “harvesting,” the loss you are able to offset taxes on both gains and income. It’s a practice used during downturns to offset gains that may have been realized from sales when markets were at much higher levels. Tax loss harvesting only applies to taxable investment accounts, not retirement accounts, like IRAs or 401ks as those are tax-deferred.
Why take advantage of tax-loss harvesting?
- Reduce taxes. Tax loss harvesting can offset both capital gains and ordinary income. If you do not have any capital gains this year, you can reduce your taxable income by up to $3,000 (married filing jointly) or $1,500 (single) each year. Any losses greater than $1,500 (single) or $3,000 (married filing jointly) can also be carried forward to offset future capital gains and income.
- Maintain diversification. If the asset sold is a mutual fund and part of a diversified portfolio, and you want to maintain a diversified portfolio, you can sell the fund at a loss and replace it with a mutual fund or ETF (exchange traded fund) that targets a similar asset class. This allows you to maintain your optimal asset allocation and expected return within the portfolio. If you do sell an asset at a loss, keep in mind the IRS has imposed a 30-day wash sale rule which prohibits you from buying that same asset or a “substantially similar” asset 30 days before or after the sale. Per the IRS wash sale rule, the IRS shares an example of a “substantially similar” asset on page 56 of their publication. If you do not follow the wash sale rule, then your tax write off will be disallowed.
- Best of both worlds. If you realize a loss on the mutual fund in the middle of the year, and replace it with a similar mutual fund that experiences a gain between now and year end, you have the best of both worlds. You will have locked in a loss that offsets taxable gains or income, while owning an asset that went up in value.
At AssetGrade, tax loss harvesting is a technique that we use for our clients in order to help them maintain a diversified portfolio while minimizing their taxable income. Is now a good time for you to take advantage of tax loss harvesting? We can help.