Why You Should Consider Tax-Loss Harvesting: In this video and the article below, Amy Shepard from Sensible Money discusses why you should consider tax-loss harvesting.

Tax-loss harvesting is a strategy investors use to reduce their tax liability by selling securities that have lost value to offset capital gains from securities that have appreciated in value. The process involves selling losing securities at a loss and then using those losses to offset capital gains from other securities that have been sold at a profit. The net result is a reduction in the overall tax bill for the investor. When an investor sells a security at a loss, the loss can be used to offset capital gains from other securities that have been sold at a profit. If the losses exceed the gains, the investor can use up to $3,000 of the excess losses to offset ordinary income. Any remaining losses can be carried to future years to offset future capital gains or ordinary income. One of the key benefits of tax-loss harvesting is that it allows investors to defer paying taxes on capital gains until they decide to sell the appreciated securities. Additionally, by offsetting capital gains with losses, it can help investors reduce the overall tax bill on their investments, allowing them to keep more of their investment returns.

Article: Why You Should Consider Tax-loss Harvesting

The current stock market volatility offers some investors an opportunity to take advantage of tax-loss harvesting: selling investments at a loss, realizing that loss for tax purposes, and then using the sale proceeds to buy a similar type of investment.

By Amy Shepard, CFP

When the stock market is volatile, like right now, many people get worried and nervous about their financial situation. Rather than worrying, financial planners view this volatility as a normal part of investing, and, an opportunity for something called tax loss harvesting.

Tax loss harvesting is when you sell investments at a loss; (1) you realize that loss for tax purposes and then (2) you typically use the sale proceeds to buy a similar type of investment.

1. Realize a loss for tax purposes

For example, if you bought a DFA Emerging Markets fund for $100,000 and it’s currently worth $80,000, you would have an unrealized loss of $20,000. If you sell that fund for $80,000, you have now realized that loss of $20,000. There are two primary ways to “use” this $20,000 loss:

Offset capital gains: If you happened to sell investments at a gain earlier in the year, you can now offset that gain with the $20,000 loss. If you had realized $20,000 of gains and now $20,000 of losses, you’re at breakeven for tax purposes. If you had realized $30,000 of gains and now $20,000 of losses, that only leaves $10,000 of taxable gain.

Offset ordinary income: If you don’t have any capital gains to offset, you are able to use up to $3,000 of your losses to offset ordinary income. Say you made $100,000 in income this year; you could reduce that to $97,000 by using $3,000 of your loss. The remaining $17,000 of losses are carried forward to future years and can be used in the same two ways; to offset future capital gains or reduce ordinary income up to $3,000 per year.

2. Reinvest the sale proceeds

Back to the example above – you sold a DFA Emerging Markets fund for $80,000 but you originally paid $100,000 for it. While the $20,000 loss has clear tax benefits described above, you still don’t want to keep the $80,000 in cash because then you are stuck with the loss forever – that $80,000 won’t ever have a chance to grow back to the $100,000 you started with because it’s no longer invested.

This leads to the next piece of tax loss harvesting – reinvesting the proceeds. There are typically two ways to do this:

Reinvest the proceeds in a similar type of investment: If your financial plan and investment mix still call for Emerging Markets holding, you could sell the DFA Emerging Markets fund and replace it with something similar, like a Schwab Emerging Markets fund.

Reinvest the proceeds to a different asset class: Sometimes, the investment you own doesn’t make sense for your financial plan or goals. If those investments are down in value, it can make sense to sell them for a loss and then use the proceeds to invest in asset classes that are a better fit for your financial plan.

For example, say you own a US Large Cap fund that’s down in value, but your asset allocation plan calls for little to no US Large Cap holdings. You could sell the US Large Cap fund, realize the loss for tax purposes, then reinvest the proceeds into something that’s a better fit for your plan, such as US Small Cap Value or International Equities for example.

While the concept of tax loss harvesting is fairly straightforward, there are some pitfalls to be aware of:

The first thing to know is that tax loss harvesting can only be done in taxable brokerage accounts – there’s no tax benefit to doing it in retirement accounts like 401(k)s or IRAs.

Be aware of wash sale rules – these rules state that if you sell an investment at a loss and then buy a “substantially identical” investment within 30 days before or after the sale, the loss is disallowed for tax purposes. This is especially important for those who are actively participating in Employee Stock Purchase Plans (ESPPs), have RSUs vesting, or have their investments set to automatically reinvest dividends or capital gains.

If you have a taxable brokerage account and assets you own are currently worth less than what you paid for them, that is a prime opportunity for tax loss harvesting. While we normally don’t like to sell investments at a loss, tax loss harvesting is the exception.

About the author: Amy Shepard

Amy Shepard, CFP®, RMA®, BFA®, MBA, is a partner and financial planner with Sensible Money. She has a passion for financial planning and loves working with clients to help them gain the financial confidence to live the life they envision. Amy has a Bachelor’s in Accounting and an MBA. She is a CERTIFIED FINANCIAL PLANNER professional, a Retirement Management Advisor®, and a Behavioral Financial Advisor .

It’s important to note that it should be done in accordance with IRS rules and regulations to avoid any violation. Also, it’s recommended to consult a tax professional before implementing any tax-loss harvesting strategy. For more finStream videos featuring Amy Shepard, please click on this link: https://www.finstream.tv/featured/amy-shepard/