By Will Paustian, CFP®
In a volatile market, like we are currently experiencing, many investors experience losses in their portfolios—and those who had realized gains are now worried about what to expect come tax season. It’s understandable to feel like this is a lose-lose situation, either you lost money on your investment or you’re going to owe more in taxes for realizing capital gains.
If you can resonate with either scenario—don’t panic yet! Tax-loss harvesting may be able to minimize your tax liability and help you make the most of an investment loss.
What Is Tax-Loss Harvesting?
Tax-loss harvesting is the strategy of selling investments at a loss in order to offset the realized gains in your portfolio. By realizing a capital loss, you are able to counterbalance the taxes owed on capital gains. The investments that are sold are usually replaced with similar securities in order to maintain the desired asset allocation and expected return.
Why Should You Use Tax-Loss Harvesting?
There is an upside to having an investment loss. Not only can it be used to reduce your tax liability, but it also helps to boost the overall rate of return for your portfolio. Here’s how it works.
Imagine you had an investment worth $100,000 at the beginning of the year that increased to $110,000 by December. This represents a pre-tax return of 10%, or 6.3% after taxes (based on a 37% tax rate).
Now imagine that same investment decreased to $90,000 in June and you decided to use the tax-loss harvesting strategy instead of holding it through December. You would have realized a $10,000 capital loss which could be used to offset capital gains or even taxable income. Assuming you are in the 37% tax bracket, you could save up to $10,000 x 37% = $3,700 in taxes, adding a 3.7% return to your original $100,000 investment. If you also used the proceeds from selling your loss to purchase additional shares of a similar stock that also gained by December, then your net after-tax return on your investment would be 6.3% + 3.7% = 10%.
It may seem complicated, but tax-loss harvesting actually works to increase your overall returns by leveraging losses to work in your favor.
There are limitations to be aware of as you consider whether tax-loss harvesting makes the most sense for you.
- Wash sale rule. The IRS prohibits tax deductions if an investor sells a security at a loss and then purchases the same or “substantially similar” security within 30 days. (1) This is an important limitation to keep in mind, as investors often replace losses with similar securities in order to maintain a specific asset allocation. One way around this rule is to purchase a mutual fund or ETF that targets the same sector as the stock you sold.
- Tax liability limit. Harvested losses are used to offset capital gains first. If the amount of the loss exceeds the amount of your gain, then up to $3,000 can be used to offset other taxable income. Anything beyond $3,000 must be carried over to the following tax year. (2)
In light of these limitations, tax-loss harvesting makes the most sense for actively managed investments. At JGP Wealth Management, investment management is our specialty.
Learn More About Your Options
Do you have losses sitting in your portfolio? Are you interested to learn more about how tax-loss harvesting can work in your favor? Get in touch with us today. JGP has the tools and expertise to actively manage your accounts, helping you maximize the value in every investment transaction. Take the first step toward minimizing your tax liability by reaching out to me at firstname.lastname@example.org or 503-446-6450.
Will Paustian is a financial advisor at JGP Wealth Management, an independent, fee-based financial advisory firm in Portland, Oregon. Since joining the JGP family in 2020, Will has played an integral role in the firm by combining his knowledge of the financial world with a strong and dedicated work ethic in order to help our clients achieve their financial goals. Will is known for his commitment to walking our clients through everything they face in their financial lives, celebrating their victories along the way. He specializes in serving executives and entrepreneurs, specifically in the food and beverage industry and business owners planning to pursue an exit, tailoring his solutions to fit their unique financial challenges and opportunities.
Will graduated from the University of Oregon’s Robert D. Clark Honors College with a bachelor’s degree in finance and entrepreneurship, minoring in economics and is a CERTIFIED FINANCIAL PLANNER™ professional. He was awarded the Stamps Leadership Scholarship and served as a student trustee on the University Board of Trustees. He also spent time abroad in the UK studying behavioral economics at the University of Oxford. When not in the office with clients, Will enjoys a wide variety of activities, from hiking and fishing to cycling and traveling. He, along with his family, enjoys the sights and sounds of Oregon, cheering on the Oregon Ducks and the Portland Trailblazers and exploring the unique restaurants and businesses around the Portland area. To learn more about Will, connect with him on LinkedIn.