When we invest money, our main objective is to see the money grow. When we think about market losses and downturns, we may think of painful periods where we watch our account balances decrease instead of grow. While market losses are never fun, they are unfortunately a part of the normal investment life cycle. However, when market volatility hands us losses, there are some options to make lemonade out of lemons.
What is tax loss harvesting?
Tax loss harvesting is the process of selling securities while they are at a loss, realizing that loss for tax purposes, and then redeploying that money into another investment (such as a different stock, bond, or mutual fund). The IRS does not allow you to sell an investment at a loss, receive the tax benefit, and then immediately reinvest those proceeds into the exact same security right away. Selling a security and re-purchasing it within the same 30-day window is called a “Wash Sale.” You can avoid triggering the Wash Sale rule by investing in something similar but different enough to avoid having the rule apply.
While most people will tend to do this only once at year end, this is actually something that can be done at any time in the year with no limit as to how frequently you do so. With custom indexing and commission-free trading, frequent tax loss harvesting has become more achievable than ever. In years of high volatility, frequently harvesting tax losses can have a big impact on your tax bill.
Keep in mind that for this strategy to work, you must have capital invested in a taxable, non-retirement brokerage account. Your 401(k) and IRA are not eligible for tax loss harvesting.
How does it benefit you?
In years of extreme volatility, you may be able to accumulate a large amount of tax losses in a short period of time. These losses can then be used to offset future capital gains. If you end up with more tax losses than you have gains to offset them in any given year, you can use the losses to offset up to $3,000 of ordinary income on your tax return.
You will be able to carry forward an unlimited amount of these losses into future tax years until you’ve been able to use them up.
Tax loss harvesting can be especially useful for investors who might have highly concentrated company stock with a large amount of unrealized gains, or other legacy investments that they’ve been holding onto to avoid a large tax impact. These tax losses can be used to help decrease single stock risk and sell off legacy assets with little to no tax impact.
What are the next steps?
If you are a Warren Street client, we are already doing this for you (as applicable). For clients with larger taxable brokerage accounts invested in our custom indexing strategy, you will likely see tax loss harvesting happening on a more frequent basis.
All in all, seeing losses reported on your Form 1099 form is not necessarily a bad thing. While your long term objective remains the same in terms of seeking growth, taking advantage of short term volatility through tax loss harvesting can lead to a nice tax perk that can aid in your overall financial return on investments in the long run.
If you have any questions or would like to speak with one of our advisors for complimentary portfolio review, you can schedule a consultation here.
Justin D. Rucci, CFP®
Wealth Advisor, Warren Street Wealth Advisors
Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor
The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.