Investors always want, and expect, their investments to go up in value. From time to time, however, an investment may fall below its initial purchase price. When that happens, there is a strategy that can turn a market decline into an opportunity. If the investment is held in a taxable account then tax-loss harvesting may help reduce your tax bill this year. Between now and the end of the year we will review your taxable accounts to see if this strategy can benefit you.
What is tax-loss harvesting? First, this strategy entails selling the underwater security to realize a capital loss for tax purposes. The second step is to purchase a similar but not substantially identical security to replace the one that was sold at a loss to maintain your target asset allocation.
So, what have you gained? Tax-loss harvesting can reduce your current and future tax bill. The loss can offset any capital gains recognized this year or reduce ordinary income by up to $3,000. For taxpayers in the 25 percent federal tax bracket, this can mean $750 or more in tax savings. Unused losses can be carried forward to future years.
Even if other investments have not gone up in value this year, you may receive capital gain distributions from mutual funds. Not every fund distributes gains each year, and a fund may even make a capital gain distribution in a year where it has posted a loss. We receive information regarding estimates of capital gain distributions ahead of time and use this information to plan for tax-loss harvesting activities.
When the replacement security is sold in the future, it will have a lower cost basis and thus a higher gain. However, tax-loss harvesting has enabled you to realize a current tax benefit today by offsetting capital gains and ordinary income in the near term. The savings that you realize may be compounded over many years until the security is eventually sold.
If you have questions about this topic, or have realized gains or losses in a taxable account that is not under our management, please contact a member of your planning team.
We do not provide tax advice, please consult a tax professional if you have any questions.