Harvest Your Tax Losses Throughout the Year

Summer just ended: Why am I writing about tax-loss harvesting?

Tax-focused articles tend to proliferate at the end of the year. These reminders are often helpful. Unfortunately, many investors end up thinking that tax-loss harvesting can be managed handily in December, as they make last-minute trades to balance out capital gains with losses for better income-tax outcomes.

Assess Your Retirement Plan as the Markets Roil

In fact, tax-loss harvesting is a tactic best performed whenever its advantages are ripe, at any time of year. In this age of volatile markets, for example, the loss you could have sold—and reaped for a tax offset—last September might have been back to significant positive territory well before Halloween.

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Selling that holding for a loss in September and then buying it again 31 days later to adhere to the IRS's wash-sale regulations could have banked you a capital loss to offset capital gains. You might also have been able to offset up to $3,000 of ordinary income.

Sound simple? It's not exactly. There are critical concerns to be weighed, including the disciplined purchase of a proxy—a comparable security—for the sold holding during the 30 day-period when wash-sale rules don't permit you to get back in. Here are five things you need to know:

1. Understand the rules.

The IRS requires you to start by offsetting like-gains with like-losses. You offset long-term capital gains with long-term capital losses (long-term is defined as held for one year or more). Ditto with short-term-gain offsets, which are taxed as ordinary income. Any remaining losses—including long-term losses—can be applied against ordinary income for a maximum of a $3,000 offset per year.

If you've done all that and have still more harvestable losses, these can be carried forward into future tax years—indefinitely. There is no limit to the amount of losses you can carry forward.

The IRS's wash-sale rule stipulates that you can't purchase any "substantially identical" security or stock whose loss you apply to offset gains for 30 days before or after you sell that security. Nor can you obtain an option or contract to acquire that security during this period. And keep in mind: This rule applies to securities purchased by you and your spouse, as well as those held in non-taxable accounts such as individual retirement accounts, trusts held in your names and even companies you hold through your tax ID.

2. Consider your entire tax picture and long-term goals.

Know your tax rate now and when it may change—if you're planning to retire or return to work soon, for example. This is key to understanding how much any contemplated tax-loss harvest might benefit you. Many new retirees find themselves in a more hospitable income-tax environment: Filers in the two lowest tax brackets pay 0% on long-term capital gains.

Investors often juggle multiple goals for multiple accounts. And we all also face a host of uncertainties and unclear time horizons for many major life events. The point is, you still need to set out long-term goals that attempt to take all of these into account as best you can. Any move you make in your portfolio to create a tax efficiency should honor your long-term investment planning.

3. Make sure the reward is worth the risk.

Every trade represents potential risks. In the case of tax-loss harvesting, one of the most obvious risks is that the market ends up moving in ways you didn't anticipate. Is selling that particular holding worth your while? Is it a unique positioning that has no obvious replacement or proxy? Let's go back to the wash-sale rule. What if you're sitting on a loss in a stock whose long-term potential, in your view, is quite strong? Why would you take on the risk that the market will see things your way in the next 30 days, and send the stock rocketing upward?

At my firm, we set a dollar threshold for tax harvesting in positioning portfolios. If the loss doesn't meet that threshold, including trading costs, the harvest doesn't happen—the tax benefit gained from selling must be significant enough to merit the risk taken on.

4. Follow a discipline.

Here at Halbert Hargrove, we're strategic in our asset allocation. If I do harvest a loss for a client, I make sure that the holding is replaced immediately by a proxy that is highly correlated to it.

In the example above, I referenced an individual stock. As long-term investors, our discipline prevents us from jumping in and out of great stocks with attractive long-term prospects. But in the case of mutual funds and exchange-traded funds, it's easier to find proxies that meet the IRS's wash-sale rule of not being "substantially identical" securities. For these holdings, you can likely find an ETF proxy that's highly correlated—but tracks a different index. Let's say you harvest a large-cap mutual fund. You could then purchase an ETF that tracks an index like Standard & Poor's 500-stock index as a proxy, holding it for 30 days. On the 31st day, you sell the proxy and get back in the original fund that best meets your portfolio's strategic positioning.

For my clients, I check for potential harvesting opportunities at least once a month. And I make sure we create as small a tracking error as possible in timing trades and getting similar pricing. The key here is continuing to maintain your asset allocation exposure—and sticking to your discipline.

5. If it's the right thing to do, go for it.

I seem to have mentioned a lot of "don'ts." Here's another: If a harvestable tax loss meets your criteria, don't wait. You might as well leverage the volatility in today's markets. There's a time value to money, and a capital gains tax deferred is like getting an interest-free loan from the IRS.

By all means, harvest those losses and defer away.

Midyear Strategies to Cut Your 2016 Tax Bill

Russ Hill CFP®, AIFA® is CEO and Chairman of Halbert Hargrove, based in Long Beach, CA. Russ specializes in investing, financial planning and longevity-awareness solutions.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Russ Hill CFP®, AIFA® is CEO and Chairman of Halbert Hargrove Global Advisors LLC, an independent registered advisory firm based in Long Beach, CA. He has led the firm for more than 40 years, specializing in investing, financial planning and longevity-awareness solutions. Russ is heavily involved with Stanford University's Center on Longevity, and has helped to launch the Center's symposiums and Design Challenges on aging-related challenges.