Tax Loss Harvesting

October 25, 2018
Tax Loss Harvesting

Want to impress your friends with knowledge of reducing your taxes using investment sales? Great! Tax loss harvesting it is…

We all know the adage, “buy low, sell high.” Well, sometimes, your investments don’t turn out the way you wanted them to, and you may want to consider selling low. Tax loss harvesting is when you sell a security (e.g., stock, bond, etc.) that has a loss, meaning, you bought it at one price, and it went down in value. When you sell, you “realize” the loss. This can potentially reduce your taxes, since investment losses are deductible.

One would typically sell a security to realize the loss, then use the proceeds to invest in something similar, but not TOO similar. You want to keep your money invested and working for you; however, the “wash-sale rule” disallows the loss from your tax return, if you buy back the same or a very similar security within 30 days.

Let’s use numbers to spell this out further.

Let’s say I own Apple stock. Pretend there is some magical universe where Apple’s share price drops. I bought it at $80/share, and it dropped in value to $60/share. Bahahaha, I know, let’s all laugh about how ridiculous that is.

Own

1,000 shares

Cost Basis at Purchase

$8,000 ($80/share x 1,000 shares)

Stock Value Now

$6,000 ($60/share x 1,000 shares)

Paper loss of

$2,000 ($6,000 sale price - $8,000 cost)

 

I decide that I want to sell the stock to realize the loss of $2,000, because I really want that loss for my tax return to reduce my income. I sell the stock on 10/31/18 and boom, $2,000 loss for my taxes.

However, if I foolishly buy 1,000 shares of Apple stock within 30 days, I will not get to deduct the loss on my tax return. It instead will be added to the cost basis again.

Own

1,000 shares

Cost Basis at Purchase

$8,000 ($80/share x 1,000 shares)

Stock Value Now

$6,000 ($60/share x 1,000 shares)

Paper Loss

$2,000 ($6,000 sale price - $8,000 cost)

Disallowed Loss Added to basis

$2,000 disallowed loss + $8,000 original cost basis = $10,000 NEW cost basis

I can re-buy the Apple stock after 31 days without violating the wash-sale rule. The rules get even trickier with multi-investment portfolios because if you buy a similar portfolio, the sale can be subject to the wash-sale disallowed loss.

Why would someone engage in tax loss harvesting?

Well, taking a tax deduction helps you to lessen the pain of having lost money in the stock market. If you are going to re-buy the security anyway, and am in it for the long-term, you can defer any gains until the future. It is important to note that tax loss harvesting only defers income taxes, because when you rebuy the security, you are potentially kicking the can down the road to pay tax on the gain from the new purchase.

Also, you may want to offset some of the gains in your investments. You can use capital losses, that you get from tax loss harvesting, to offset capital gains. Any additional loss, above and beyond the amount of your gains can be deducted against ordinary income, up to $3,000 per year, and can be carried forward indefinitely.

We might need a numerical example for this.

Let’s say I own an investment in my taxable account, and it has paid out $5,000 of capital gains. If I use the above example with Apple stock, and take the loss of $2,000, I can count that against my gains, and now have a NET gain of only $3,000 to pay taxes on.

Now let’s say instead I have only $500 of gains for the year. If I use my $2,000 loss, I can offset my entire gain, and still have a NET loss of $1,500 to apply towards the rest of my taxable income.

It is important to approach tax loss harvesting with caution. If you don’t quite understand how this all works, be sure to ask your financial advisor to help.

 

While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax matters. You should discuss tax matters with the appropriate professional.

Any opinions are those of Jill Carr and not necessarily those of RJFS or Raymond James. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.

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