What is Tax Loss Harvesting?

Cheri Franklin |


With the recent market volatility, especially in the fourth quarter of 2018, some opportunities for tax loss harvesting appeared, particularly for those investors who purchased equities in late 2017 and 2018. Tax loss harvesting simply means capturing a realized loss by selling a position. It can be either short-term or long-term. Ideally, the cash raised from the sale would be fully invested, and the original position would be repurchased after 31 days to avoid the wash sale rule. In some cases, it may make sense to leave the funds in the replacement security, especially if it has significantly appreciated over the 31 days. The replacement security should not be substantively identical to the original security. For example, the proceeds from selling the Vanguard S&P 500 Index Fund should not be used to purchase the SPYDER S&P 500 exchange-traded fund. In fact, the latter should not be purchased in any account within 31 days before or after the loss on the former was realized.

Once a loss is realized, what can an investor do with it? First, up to $3,000 can be deducted from ordinary income. Second, it can offset any realized gains, with the remainder carried forward for future use. How does this work in reality? Here is an example: Suppose Joe Sixpack invests $500,000 into a US equity fund that depreciates to $450,000 whereupon he decides to harvest the $50,000 loss and moves into a similar but not identical fund in which he now as a cost basis of $450,000. Now suppose a few years later the fund appreciates to $600,000, and Joe decides to sell $60,000 for the purpose of rebalancing. If Joe had never done tax loss harvesting, he would incur $10,000 of capital gains and owe the resulting taxes. With the tax loss harvesting, Joe would incur $15,000 of gains, but he could offset that against his loss carryforward and avoid any capital gains taxes. Of course, if Joe were to sell the entire position all at once, then he arguably would not be better off with the tax loss harvesting. However, wise investors choose their investments carefully and hold them for as long as possible. If he doesn’t die with it, Joe could always donate the investment to charity, thereby avoiding any capital gains taxes while receiving a nice tax deduction, assuming he itemizes.

If you believe you are in a position to do tax loss harvesting and your advisor has not offered it to you, it may be time to look for a new advisor. If you would like to learn more about how Clarity utilizes tax loss harvesting for our clients, please email us at info@clarityca.com or call us at 800-345-4635.