Is it time to harvest some tax losses? Could be, given the volatile stock market.
The strategy — selling losing investments to reduce taxes on winners — gets lots of attention at the end of the year. But there’s no reason not to do it at the start of the year, or in the middle. Remember, Dec. 31 is just a deadline — it’s the last date for a sale that can be claimed in the return due the next April. The math works just as well no matter when you do it.
“If loss harvesting is to be an integral part of portfolio strategy, starting earlier tends to be better than later,” says Vikas Oswal, president and CEO of Advisor Partners, an asset manager in Walnut Creek, California.
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“Starting earlier in the year allows an investor to take advantage of market ups and downs,” he says. “Having more time potentially allows for multiple harvesting opportunities and a greater quantity of losses, which in turn allow the investor to take gains on holdings showing gains.”
This year started with stocks falling off a cliff, offering many opportunities to harvest tax losses. And although the market has recovered, many experts expect plenty more ups and downs, given the uncertainty in economies around the world.
Consider these facts. Basically, a loss on a stock, bond, mutual fund or other investment must be “realized” before it can be claimed for taxes. That means the holding must be sold.
If you spent $10,000 on shares in XYZ Corp. a few years ago and sold them now for $6,000, the $4,000 loss could be used to offset $4,000 in gains from one or more other investments you had sold, eliminating the capital gains tax on those profits. If losses exceeded gains, they could be used to reduce your taxable income by up to $3,000 a year. Or the loss could be carried forward to offset capital gains or income in future years.
Harvesting losses early and often, rather than waiting to the end of the year, allows the investor to move money to more promising investments sooner, Oswal says.
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It also has psychological benefits, says Warren A. Ward, a certified financial planner with WWA Planning & Investments in Columbus, Indiana. “If we buy a stock that does well, then falls off our buy list, it’s a lot easier to decide to sell and take the gain if we’ve already booked a loss elsewhere to help manage the taxes,” he says.
But this doesn’t mean every investment should be sold the moment it shows a loss, since any holding could rebound. As a basic practice, the investor should look at each holding and ask: “Regardless of how it has performed in the past, would I buy it at today’s price?” If the answer is yes, keep it. If it’s no, sell. (This goes for winners, too.)
Keep your emotions at bay. For many investors, following this simple procedure is easier said than done, says Daryl Dagit, a financial advisor with Savant Capital Management of Rockford, Illinois. “Most investors allow emotion to enter the picture and do not want to admit they made a mistake on a stock pick, and will want to wait it out for the stock to return to at least a breakeven point,” he says. “You are better off taking the loss to help on your taxes and reinvest the money.”
So even if you think your holding will rebound someday, it’s important to think about whether your money could grow faster in something else.
It is possible to have it both ways, selling the investment to lock in the loss and then buying it again to get any future gains. The IRS, of course, is aware of this, and uses the wash-sale rule to prevent abuse. It disallows a loss if the same security, or one “substantially identical” to it, is purchased within 30 days before or after the sale.
“Substantially identical” means you can’t get away with selling Vanguard’s S&P 500 index fund and buying Fidelity’s S&P 500 Index fund. But you could avoid the problem by selling the index fund and buying a fund that is different but would behave much the same way, such as a one filled with stocks of large U.S. companies.
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With individual stocks, it’s often possible to find an alternative.
“You sell Coke (ticker: KO) to buy Pepsi (PEP), which clearly avoids the wash-sale rules,” says David E. Du Val, chief of consumer advocacy at TaxAudit.com, a tax-consulting firm in Citrus Heights, California.
Take a loss to rebalance. On some occasions, an investor might want to realize a loss not because the investment has no future, but in order to diversify or rebalance the portfolio. That may happen, for example, when one has accumulated a large block of a single stock over time, through tremendous performance, reinvested dividends or in an employee stock purchase program. If the shares were accumulated at various prices, the investor can trim in the most tax-beneficial way by selling those shares that show a loss — the ones bought at the highest prices.
Generally, this is done by telling the broker or fund company to sell shares that had been bought on one or more specific dates. You must designate them at the time of the sale, not just claim those shares when you do your tax return.
Calculating the tax savings from a sale can be tricky, since that depends on whether it was a short- or long-term capital loss, and whether the gain it offsets is long-term or short. Also, many investors don’t know early in the year what tax bracket they’ll be in at the end, or how many gains and losses they’ll have booked by Dec. 31.
Final thoughts. It’s not necessary to know the tax implications down to the penny if you keep one cardinal rule in mind: don’t let the tax tail wag the investing dog. The main idea is to get rid of investments that aren’t likely to do well in the future, to put that money to better use. The tax benefit, large or small, is gravy.
“The most important consideration is whether the security is or is not a good investment, not what the tax benefit might be if you sold it at a loss,” says Alan Straus, a certified public accountant in New York. “If a rebound is anticipated, then do not sell. If you want out of the stock, then sell it.”
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Sell Stocks Year-Round to Minimize Tax Losses originally appeared on usnews.com
