THE BENEFIT OF TAX LOSS HARVESTING

With a broadly diversified portfolio, it is quite likely that some investments will decline in value from their purchase prices. When this happens, there is sometimes an opportunity to add value to your portfolio through a strategy called “tax loss harvesting.”

Tax loss harvesting works by selling investments whose value is below their purchase price, thereby “harvesting” the loss. Harvested losses can be applied to offset capital gains generated elsewhere in your investment portfolio, as well as up to $3,000 in ordinary income annually. Any losses that cannot be applied in a given tax year can be carried over indefinitely to offset future income and capital gains.

Anyone with earned income or a taxable investment portfolio may benefit from tax loss harvesting. The potential benefit from this strategy depends on your income level and the amount of short and long-term capital gains, but can be substantial. Short-term capital gains rates, which apply to assets held for one year or less, are the same as the marginal tax rate you pay on ordinary income. Long-term capital gains, those realized from investments held for more than a year, are taxed at lower rates that vary based on income level. The rules for applying harvested losses to other gains are somewhat complicated, so a thorough understanding is required.

Tax planning, including loss harvesting, is a component of the year-round investment process that we employ for our clients. We carefully review the performance of the managers that make up our client portfolios, and periodically will sell positions to record a tax loss. If we identify an opportunity to harvest a loss, but still feel that the holding is appropriate for a client portfolio, we will sometimes repurchase the same security after waiting at least 31 days. By waiting 31 days, the owner is not subject to “wash sale” rules that effectively temporarily disallow the harvested losses. We will sometimes also use similar (though not “substantially identical”) replacement securities, such as an exchange traded fund. This approach makes the use of tax loss harvesting even more valuable as we can offset gains from our clients’ investment accounts without altering the strategic positioning of their portfolios.

Effective tax management of portfolios is an important part of a sound investment strategy. While the rules are complex, a myriad of possibilities exist.  Executed properly, tax loss harvesting can significantly benefit the investor experience.  As always, we would be pleased to discuss your specific situation in detail.