The Benefits of Tax Loss Harvesting

By Nicholas Guido, CFP®

November 27, 2019

Estimated Reading Time: 7 minutes

The Benefits of Tax Loss Harvesting

As we close out 2020, we look for opportunities to help our clients better their after-tax return and improve their tax liabilities. Even in massively strong growth in the market (like 2019), not every investment will be a winner.

Turning Losses into Winnings

Fortunately, losing investments can be beneficial to you and your family - you may be able to use them to lower your tax liability and better position your portfolio for future gains. This strategy is called tax loss harvesting and is one of the many tax strategies that we implement for our clients.

Tax loss harvesting works in the following ways:

  1. Sell a position that is at a loss.
  2. Re-invest the proceeds into a similar position, but different enough that you do not create a wash-sale.
  3. Then, you use the loss to reduce your taxable capital gain and potentially offset up to $3,000 of your ordinary income.

This strategy can seem very simple on the surface, so below is an example to clarify how tax loss harvesting works.

How Tax Loss Harvesting Works

Image

Let’s say you recognize a gain of $20,000 on a stock you bought less than a year ago (Investment A in the example). Because you held the stock for less than a year, the gain is treated as short-term capital gain and will be taxed at the higher ordinary income rates (rather than the lower long-term capital gain rates, which apply to investments held for more than a year).

At the same time, you also sell shares of another investment for a short-term capital loss of $25,000 (Investment B in the example). Your $25,000 loss would offset the full $20,000 gain – you’d owe no taxes on the gain and the remaining $5,000 loss could be used to offset $3,000 of your ordinary income. The leftover $2,000 loss could then be carried forward to offset income in future tax years.

Assuming you’re subject to a 35% marginal tax rate, the overall tax benefit of harvesting those losses could be as much as $8,050 ($20,000 of offset capital gain + $3,000 current-year deductible loss against ordinary income X 35% = $8,050 of total savings).

Advantages & Disadvantages of Tax Loss Harvesting

There are a number of other things to consider when you are implementing this strategy, some are advantages and disadvantages.

Disadvantages:

  • Tax loss harvesting is not a useful strategy in qualified accounts, such as, 401(K) or IRAs because any gain that is realized is deferred and, per the IRS, cannot be deducted.
  • The IRS also creates guidelines around which types of losses can be used to offset gains.
  • Lastly, closely monitoring the sales and purchases in all your accounts is imperative because you can create what is known as a wash-sale. This is applicable to all social security numbers for your tax filing. The wash-sale rule states that if you sell a security at a loss and purchase a security that is “substantially identical” within 30 days then the loss is negated.

Advantages:

  • Offsetting your gains with losses; through tax loss harvesting there is an order to which you must offset your gains. First you must use short-term losses to offset short-term gains, then use long-term losses to offset long-term gains, and then secondly you can use additional losses from either long-term or short-term losses to offset either long-term or short-term gains.
  • Additional losses above the gains that you currently have can be used to offset up to $3,000 of ordinary income.
  • The tax losses that you realize can be carried forward indefinitely and be used to offset gains in the future to help drive down your tax liability and increase your after-tax return.

Direct Indexing & Tax Loss Harvesting

Chicago Partners is dedicated to helping our clients drive up their after-tax return each year and we do this through our 5-Step Wealth Optimization Process. As we continue to strive to better this offering, we look for innovative ways to enhance each component.

The newest initiative is Direct Indexing. Direct Indexing allows us to directly invest in asset classes such as the S&P 500 while avoiding the fund management fees. The benefit is through the fact that you will own all of the underlying components of the S&P 500 and not the index. The advantage comes because there will be opportunities to harvest losses in the underlying 500 names that may not arise if you were buying the S&P 500 through a mutual fund or ETF.

Direct Indexing can be beneficial because in years when the stock market is rallying tax loss harvesting will be harder to implement, which is why when the market corrects or has a downturn, you should be looking for opportunities to harvest losses and creating a war chest of losses to carry forward.

If your advisor is not looking for these opportunities in years that your portfolio, asset class, or an individual security struggles, then you are not optimizing your after-tax return to its fullest extent.

For more information on Direct Indexing or tax loss harvesting please review our next blog post or please contact me via email or phone at your convenience.

Image

Nicholas Guido, CFP® is a Wealth Advisor at Chicago Partners. Nick works directly with clients, creating investment, tax, and financial plans that help clients optimize the management of their wealth.


Important Disclosure Information

Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Chicago Partners Investment Group LLC (“CP”), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CP. Please remember to contact CP, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. CP is neither a law firm nor a certified public accounting firm and no portion of the commentary content should be construed as legal or accounting advice. A copy of the CP’s current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request.

November 27, 2019

Estimated Reading Time: 7 minutes

The Benefits of Tax Loss Harvesting

As we close out 2020, we look for opportunities to help our clients better their after-tax return and improve their tax liabilities. Even in massively strong growth in the market (like 2019), not every investment will be a winner.

Turning Losses into Winnings

Fortunately, losing investments can be beneficial to you and your family - you may be able to use them to lower your tax liability and better position your portfolio for future gains. This strategy is called tax loss harvesting and is one of the many tax strategies that we implement for our clients.

Tax loss harvesting works in the following ways:

  1. Sell a position that is at a loss.
  2. Re-invest the proceeds into a similar position, but different enough that you do not create a wash-sale.
  3. Then, you use the loss to reduce your taxable capital gain and potentially offset up to $3,000 of your ordinary income.

This strategy can seem very simple on the surface, so below is an example to clarify how tax loss harvesting works.

How Tax Loss Harvesting Works

Image

Let’s say you recognize a gain of $20,000 on a stock you bought less than a year ago (Investment A in the example). Because you held the stock for less than a year, the gain is treated as short-term capital gain and will be taxed at the higher ordinary income rates (rather than the lower long-term capital gain rates, which apply to investments held for more than a year).

At the same time, you also sell shares of another investment for a short-term capital loss of $25,000 (Investment B in the example). Your $25,000 loss would offset the full $20,000 gain – you’d owe no taxes on the gain and the remaining $5,000 loss could be used to offset $3,000 of your ordinary income. The leftover $2,000 loss could then be carried forward to offset income in future tax years.

Assuming you’re subject to a 35% marginal tax rate, the overall tax benefit of harvesting those losses could be as much as $8,050 ($20,000 of offset capital gain + $3,000 current-year deductible loss against ordinary income X 35% = $8,050 of total savings).

Advantages & Disadvantages of Tax Loss Harvesting

There are a number of other things to consider when you are implementing this strategy, some are advantages and disadvantages.

Disadvantages:

  • Tax loss harvesting is not a useful strategy in qualified accounts, such as, 401(K) or IRAs because any gain that is realized is deferred and, per the IRS, cannot be deducted.
  • The IRS also creates guidelines around which types of losses can be used to offset gains.
  • Lastly, closely monitoring the sales and purchases in all your accounts is imperative because you can create what is known as a wash-sale. This is applicable to all social security numbers for your tax filing. The wash-sale rule states that if you sell a security at a loss and purchase a security that is “substantially identical” within 30 days then the loss is negated.

Advantages:

  • Offsetting your gains with losses; through tax loss harvesting there is an order to which you must offset your gains. First you must use short-term losses to offset short-term gains, then use long-term losses to offset long-term gains, and then secondly you can use additional losses from either long-term or short-term losses to offset either long-term or short-term gains.
  • Additional losses above the gains that you currently have can be used to offset up to $3,000 of ordinary income.
  • The tax losses that you realize can be carried forward indefinitely and be used to offset gains in the future to help drive down your tax liability and increase your after-tax return.

Direct Indexing & Tax Loss Harvesting

Chicago Partners is dedicated to helping our clients drive up their after-tax return each year and we do this through our 5-Step Wealth Optimization Process. As we continue to strive to better this offering, we look for innovative ways to enhance each component.

The newest initiative is Direct Indexing. Direct Indexing allows us to directly invest in asset classes such as the S&P 500 while avoiding the fund management fees. The benefit is through the fact that you will own all of the underlying components of the S&P 500 and not the index. The advantage comes because there will be opportunities to harvest losses in the underlying 500 names that may not arise if you were buying the S&P 500 through a mutual fund or ETF.

Direct Indexing can be beneficial because in years when the stock market is rallying tax loss harvesting will be harder to implement, which is why when the market corrects or has a downturn, you should be looking for opportunities to harvest losses and creating a war chest of losses to carry forward.

If your advisor is not looking for these opportunities in years that your portfolio, asset class, or an individual security struggles, then you are not optimizing your after-tax return to its fullest extent.

For more information on Direct Indexing or tax loss harvesting please review our next blog post or please contact me via email or phone at your convenience.

Image

Nicholas Guido, CFP® is a Wealth Advisor at Chicago Partners. Nick works directly with clients, creating investment, tax, and financial plans that help clients optimize the management of their wealth.


Important Disclosure Information

Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Chicago Partners Investment Group LLC (“CP”), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CP. Please remember to contact CP, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. CP is neither a law firm nor a certified public accounting firm and no portion of the commentary content should be construed as legal or accounting advice. A copy of the CP’s current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request.