As we near the end of 2023, year-end tax planning is a critical task. This can take a variety of forms and encompass a number of strategies and tactics. Regardless of your situation, reviewing your tax situation prior to the end of the year will give you an opportunity to make any needed adjustments prior to year-end to try to minimize your tax bite.
One strategy to consider, if applicable to your situation, is tax-loss harvesting.
What is Tax-Loss Harvesting?
Tax-loss harvesting is selling investments held in a taxable investment account in order to realize that loss. These losses can be used to offset gains realized on other investments during the year. A portion of these losses can be used to offset other income and any unused losses can be carried forward to a subsequent tax year.
Investments such as individual stocks, bonds, mutual funds, ETFs and others can be used in a tax-loss harvesting strategy. For example, if you own a stock mutual fund with a cost basis of $25,000, but whose current value is $21,400 then you would realize a loss of $3,600 if you sold all of the shares.
In other cases, you might own a fund or security where you have multiple cost basis levels due to purchases made at different times. If some of those shares are currently valued below their market value, you can sell only those shares at a loss. This may depend upon how your account custodian accounts for the cost basis of different share lots.
How Tax-Loss Harvesting Works: Gains and Losses
When working through the mechanics of tax-loss harvesting, it is important to understand the concept of short-term and long-term gains and losses. There is an ordering process in matching gains and losses.
First, short-term gains, or gains realized when the security is held for less than a year, are offset against short-term losses. Long-term gains are offset against long-term losses. Any excess gains or losses in either category are then offset against any remaining gains or losses.
To the extent that any realized losses exceed realized gains for the year, they can be used to offset up to $3,000 in other income for the year. Any remaining unused capital losses in excess of your capital gains can be carried forward for use in a subsequent tax year.
Short-term gains are taxed as ordinary income; the gain will essentially be added to your other income for the year. Long-term capital gains are taxed at preferential capital gains tax rates at 0%, 15%, or 20% depending upon your income and filing status. Some higher income taxpayers will pay an extra 3.8% depending on their income and filing status.
Beware The Wash-Sale Rule
It is important to avoid violating the wash-sale rule when doing tax-loss harvesting. The wash-sale rule says that within a 61-day period surrounding the sale of any security for a loss, you cannot repurchase the same or a similar security. This is the period 30 days prior and after the sale, plus the day of the sale transaction. Violating the wash-sale rule will prohibit you from using this loss for tax purposes.
The rule includes all accounts, meaning that you cannot sell the security for a loss in a taxable account and then purchase it inside of your IRA. The same security part of the rule is pretty straightforward. If you sell shares of stock ABC to realize a loss, you cannot go back and buy ABC shares during the wash-sale period. The same would apply to mutual funds and ETFs. If you sell shares of an S&P 500 index fund at a loss, you could not buy shares of any S&P 500 fund during this period, even if you sold a Vanguard fund and wanted to buy a Fidelity fund.
The rules are a bit vague on similar funds. For example, would a fund tracking the S&P 500 be similar to a fund tracking the total U.S. stock market? It pays to consult an advisor or tax expert to clarify this issue for your situation.
Review Your Investment Goals and Your Portfolio
Tax-loss harvesting should be considered a tool versus an objective. By this, we mean that similar to many other tax and financial planning strategies, tax-loss harvesting should be used to help achieve an objective, not as an objective unto itself.
That said, tax-loss harvesting can be useful in realigning your portfolio based on a review of investment goals and a review of your portfolio holdings. In the case of your holdings, it is a good idea to review the relative performance of holdings such as mutual funds, ETFs and stocks relative to their peers or your expectations. If there are holdings to be sold, using tax-loss harvesting can translate to tax savings on these sales inside of a taxable account.
Portfolio rebalancing, aligning your holdings with your target asset allocation for various asset classes, should be done periodically. To the extent that they are holdings to be sold as part of this process inside of a taxable account, using tax-loss harvesting can make this a more tax-efficient process and possibly help reduce your tax burden for the year.
Tax-loss harvesting should be coordinated with your overall investing strategy. It can be done at any point during the year, not just at year-end.
Please reach out to your Wedbush financial advisor to discuss how tax-loss harvesting can be a beneficial tool in your overall investment and tax planning strategy.
Wedbush Securities does not provide tax or legal advice. Please consult your tax or legal advisor.
These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information presented is not intended to constitute an investment recommendation for, or advice to, any specific person. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. The information in these materials may change at any time and without notice.