Is Tax Loss Harvesting Worth It?

Introduction

After a rough year in the market, it’s rare an investor didn’t experience losses. How you treat those losses come tax time can mean a lot in the long run of your financial plan.

“Good portfolio management focuses on after tax rate of returns,” says Ballast Advisors Managing partner Paul Parnell.

Tax harvesting is a method of investing that involves buying and selling assets in order to reduce capital gains taxes. Because markets like these don’t come everyday, you may have an opportunity to harvest losses now that you can use to offset gains in better years to come.

In this post we discuss the basics of tax harvesting and why it’s beneficial for investors—especially those with taxable accounts—to use this strategy when making investment decisions.

Basic principles of tax harvesting

Tax harvesting is not a new concept, but it has become more popular in recent years. It’s a strategy that can help you reduce your tax bill by generating losses on investments to offset capital gains and other income.

“Tax-loss harvesting can only be used with taxable accounts, not with tax-deferred accounts like a 401(k) or IRA,” explains Parnell.

“The basic idea is that if you sell an investment for less than its purchase price, then you’ve realized a loss—and that loss can be used as an offset against capital gains when you file your taxes at year-end or whenever the time comes for taxes.”

However, there are limits on how much you can deduct each year; for the 2022 tax year you can potentially offset up to $3,000 of your ordinary income. If you exceed your limit then any extra amount will be carried forward and used against future capital gains (or losses).

Researchers at MIT and Chapman University calculated that tax loss harvesting yielded almost an additional 1% annual return each year from 1928 to 2018 (Forbes, 2022)

Timing is key

“You have until Dec. 31 to harvest the losses,” says Parnell. “But even if you harvest losses this year, you do not actually have to apply them this tax year.”

Planning WHEN to offset the losses can be the key to reducing your tax burden in a long-term financial plan. In consecutive good years, investors may not have losses. It can be very important to have loss carryover for the good years.

“You have to be looking forward,” says Parnell. “We don’t have many years like this, and when we do have them, we look for opportunities to harvest losses.”

It might look good on paper to say you didn’t have any losses Parnell explains that say next year everything recovers and is in the black, you may have lost out on a big opportunity. Depending on your situation, you may have big capital gains in the future.

“For example, if you’re invested in mutual funds, capital gain distribution can be out of your control sometimes– where they may sell positions in portfolio — and out of the blue you can have a significant capital gain you didn’t anticipate,” adds Parnell. “Just by rebalancing a portfolio you can create capital gains.”

Note The IRS Wash Sale Rule: Now, this doesn’t mean you have to get out entirely, you can sell and replace with similar investments. But if you sell a security at a loss and then buy back the same or substantially identical security within 30 days before or after the sale date, you are subject to wash sale rules. If this happens, any loss on the sale will not be allowed as a deduction on your federal income tax return.

Tax harvesting can save you money, but do it right.

There are many valid reasons for selling an investment, and not all of them are based strictly on its performance. However, you shouldn’t take the decision to sell lightly, and you should carefully consider the timing of any sale. An important part of successful portfolio management is knowing when to sell and when not to. Properly and improperly timed sales can directly affect the overall return you receive from your investments.

If you’d like to learn more about how tax harvesting works and what it can do for your investment portfolio, we invite you contact us for a portfolio consultation.

There are also many other resources online that can help answer any questions you might have about this popular strategy.

ADDITIONAL SOURCES:

https://www.schwab.com/learn/story/how-to-cut-your-tax-bill-with-tax-loss-harvesting

https://www.irs.gov/taxtopics/tc409 

https://www.forbes.com/advisor/investing/tax-loss-harvesting/

The opinions expressed herein are those of Ballast Advisors, LLC and are subject to change without notice. The third-party material presented is derived from sources Ballast Advisors consider to be reliable, but the accuracy and completeness cannot be guaranteed. This material is for informational purposes only and should not be considered investment advice. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. Ballast Advisors, LLC is a registered investment advisor under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about the firm, including its services, strategies, and fees can be found in our ADV Part 2, which is available without charge upon request