Equity markets have performed well over the last few years, and that may mean your portfolio has fallen out of alignment relative to current goals, objectives, and risk tolerances. Recent equity market volatility serves as a reminder to review your portfolio composition and potentially take advantage of tax-loss harvesting opportunities. Rebalancing portfolios to their target allocation often allows for strategic realization of gains and losses by pruning lagging investments while simultaneously keeping your portfolio aligned with your goals.
The reason we invest is to make money; however, sometimes an investment will decrease in value from its original acquisition cost, creating an unrealized loss. Tax-loss harvesting allows you to turn an investment loss into a tax benefit. Tax-loss harvesting targets selling investments that are at a loss, replacing them with sometimes similar investments, and using losses to offset gains. As a result, less of your money goes to taxes and more can stay invested.
When evaluating positions for tax-loss selling, we consider investments that do not align with your strategy, have limited future growth prospects, or can be replaced by another asset fulfilling a similar role in your portfolio. There are two separate ways to utilize losses.
First, when losses are realized, they can be offset against capital gains. Short-term losses offer significant tax advantages and can offset short-term gains, which are subject to taxation at a higher marginal rate. If losses are larger than the gains, the remaining losses can offset $3,000 of ordinary income, and for married individuals filing separately, the deduction is $1,500. Second, unused losses of over $3,000 can be carried to future tax years.
According to the tax code, short-term capital losses first offset short-term capital gains, and long-term losses offset long-term gains. If losses of one category exceed the gains of the same category, then one can use the excess to offset gains in the other category. The least effective use of realizing short-term losses is applying them to long-term capital gains. Depending on the situation, this option may still be preferable to paying the long-term capital gains tax. Additionally, realizing a capital loss can still be effective even if you did not realize capital gains in the current year, since the capital loss has carryover provisions.
Tax-loss harvesting is beneficial; however, it is important to avoid violating the wash-sale rule. The wash-sale rule states, if an investor purchases the same security or a "substantially identical" security within 30 days before or after selling an investment at a loss, the tax deduction for that loss may be disallowed.
To optimize the benefits of tax-loss harvesting, year-round tax planning, and regular pruning are ways to boost after-tax returns effectively. It is important to remember not to let tax considerations dictate your investment strategy. If you decide to implement tax-loss harvesting, make sure that tax savings do not compromise the overall investment objective. A prudent approach involves maintaining a balanced strategy and regularly evaluating your investments to confirm alignment with your goals.
As your partner and fiduciary, we are here to help navigate the tax planning and investing landscape. The above summary on tax loss harvesting was for educational purposes. Please discuss with your tax advisor prior to deploying a tax-loss harvesting strategy. If you have questions or need assistance reviewing your financial situation your First American Portfolio and Relationship Managers are available for consultation.
Author:
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Jason Nerio SVP, Director of Investment Research and Strategy First American Trust |
Jason Nerio is the Director of Investment Research and Strategy at First American Trust. Mr. Nerio has more than 20 years of investment research experience. He is responsible for formulating investment strategy and serves as a leading member of the investment committee which monitors and manages the firm’s allocation strategies for over $1 billion in client assets.
The following article is for informational purposes only and is not and may not be construed as legal, tax and/or investment advice. Investments contain risks, no third-party entity may rely upon anything contained herein when making legal, tax and/or investment determinations regarding its practices, and such third party should consult with an attorney, tax advisor and/or an investment professional prior to embarking upon any specific course of action.
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