tax loss harvesting

The end of the calendar year is a good opportunity to review, adjust, and take some actions relevant to a financial plan or investment strategy.  This blog post is one in a short series examining a few of those items.  The information below is not intended as formal advice for any particular circumstance, but rather a general discussion of the topic.

DRW Financial does not provide tax advice.  The following is a general discussion of one strategy available in some circumstances.  Please consult a tax professional prior to engaging in any action with taxable consequence.

An investor may realize a "capital gain" or "capital loss" within a given calendar year if they sell an investment at a price higher or lower than what they originally paid.  Capital gains are taxed differently depending on how long the investment was held prior to sale; investments bought and sold within 12 months are generally considered "short term" and those held longer than 12 months considered "long term".  Capital gains may in some cases be offset in a given year by capital losses, and the IRS may allow a net capital loss of up to $3000 to offset some amount of taxable income.

Please see IRS discussion of capital gains and losses for more information.

This post is primarily concerned with a strategy known as "tax loss harvesting".  The general idea is that there may be value in realizing a capital loss in some circumstances due to the potential tax benefits.    Consider one hypothetical situation:

An investor buys $10,000 worth of XYZ stock in February 2014
by mid November, the stock has fallen to a value of $9,000
The investor's income places them in a tax bracket where they pay 
25% on marginal income.  Selling the stock and "realizing"
the $1,000 net loss may allow them to deduct that loss from their
income, "saving" $250 on income tax [$1,000 loss * 0.25 tax rate = $250]

Whether it makes sense to sell the investment or hold it for potential future gains depends on a number of considerations and should be discussed with relevant advisers (tax professionals and investment advisers).  In the case where the "best choice" appears to be realizing the loss, that action must be complete within the calendar year to impact that year's taxes.

Here are a few important considerations and potential obstacles to employing a tax loss harvesting strategy:

• Does it make sense to give up all future benefit of an investment to capture the potential tax benefit of the sale?  In the example above, is it likely that the $9,000 value will revert in the short term and turn into a $11,000 value and a $1,000 "gain"?
• Does your particular tax circumstance suggest this type of strategy?
• Be careful to understand "wash sale" rules.  In general terms, a "wash sale" is one where a capital loss is disallowed because you repurchased the investment within 30 days of the sale.
• Be aware of the limits on counting realized capital losses within a given calendar year; "excess" capital losses may be applied to future years in some cases; be sure to consult with your tax professional on the relevant limits and rules.

DRW Financial does not provide tax advice.  The following is a general discussion of one strategy available in some circumstances.  Please consult a tax professional prior to engaging in any action with taxable consequence.