Use This Year’s Volatility to Manage Taxes

August 18, 2022


The start of this year saw one of the worst years on record for stock market volatility and returns. Now, almost three-quarters through, the markets are beginning to rally, but there is still so much unknown going into the fall.  Many investors are sitting on some very real losses in their portfolios. While many experts advocate buy-and-hold strategies through difficult markets, there is one strategy that can really add value even when the market future is unclear.  That strategy is tax-loss harvesting.


What is Tax Loss Harvesting?

Tax loss harvesting involves temporarily selling an asset that has an unrealized loss in a taxable account. Typically, you might think of selling assets that have unrealized gains to “lock in the profit. ” When you have meaningful losses, though, it can be beneficial to sell at a loss because that captured loss will offset other gains.  The loss might offset gains already taken early in the year or yet to be taken in the current year, or they can be carried forward to offset losses in future years.

What Are The Rules of Tax Loss Harvesting?

The IRS has rules for the practice of temporarily selling securities for the sake of booking a tax loss. The IRS wants there to be an “economic consequence” to the loss; so once you sell the asset at a loss, you must wait 30 days before repurchasing the same security.   If you want to stay invested in a particular stock because it balances out your portfolio, or because you still want to invest in that company, you can buy that same asset back 31 days later. Violating this rule is called a wash sale.  If you accidentally trigger the wash sale rule, your loss will not count.

What are Some Tax Loss Harvesting Strategies?

The simplest approach to tax loss harvesting is to sell a security at a loss and buy it back 31 days later.   Many investors, however, want to keep their portfolio invested and balanced with its exposure to particular investments.

One strategy to maintain investment exposure is to use the proceeds from the sale of the first security to purchase another investment that is not “substantially identical” to the first. For example, if you sell a stock in the communications sector at a loss, such as Meta or Disney, you might then purchase a Communications Exchange Traded Fund (ETF) such as XLC.  Adding an ETF with a large weighting in the stock you sold will help maintain your exposure to the sector while you wait 31 days to repurchase the shares of the specific stock.

Another strategy to maintain investment exposure is by doubling down on an investment you believe in. If you believe strongly in Disney- as we do, you might think it is a better buying opportunity today than a time to sell.  Yet, you do have a substantial loss that might have value.  You can use available cash to buy more Disney today and double the size of your position for a short time.  31 days after the new purchase, you can sell out of the part of your holding that is at a loss, taking advantage of both an attractive buying price and still booking the accumulated loss.

Why is Tax Loss Harvesting Valuable?

In addition to potentially saving money on taxes in the moment, studies have shown that portfolios that regularly take advantage of tax loss harvesting strategies may add almost 1% to annual portfolio performance. Over time, that can make a big difference.

Even if you have realized more losses in a year than you have gains to offset the losses, it can still be beneficial to realize additional losses. Each couple or individual is allowed to recognize $3,000 in ordinary losses on their tax return, annually. Capital losses above the $3,000 threshold can then be carried forward indefinitely, offsetting future realized gains.

In volatile times, tax loss harvesting can be a valuable additional strategy to build long-term appreciation in your portfolio.  Just remember that a successful long-term investment plan will always eventually and regularly generate taxable capital gains. Tax loss harvesting is just one of several tax management strategies that your financial professional can discuss with you.  As always, when it comes to taxes, be sure to check in with your tax professional.

Interested in further discussing strategies for your assets? Let us know!

Christine Crigler, CFP ® CPWA®
Wealth Advisor