Starting my career in 2007 had its many blessings and challenges. I remember as we headed in the Great Financial Recession (“GFC”), I would be sitting in meetings with the experienced Financial Advisor I was teamed up with, and watching him handle a lot of hard conversations. Two things became clear to me throughout those hard first years: (1) My life verse as a Financial Advisor should be (Matthew 6:34) Therefore don’t be anxious about tomorrow, for tomorrow will be anxious for itself. Sufficient for the day is its own trouble” and (2) a good Financial Advisor (as was my experienced Financial Advisor at the time) will find opportunities during bad stock market events. One thing, that you should be considering today, if you have any non-retirement investments is a strategy called Tax Loss Harvesting.
What Is Tax Loss Harvesting?
Tax loss harvesting is the idea that within a portfolio you have some assets that have traded at a gain since their initial investments and some that have traded at a loss (hopefully not many). If you haven’t had the money invested very long and you run into a bear market, then you’re more than likely going to be dealing with many of your funds that are trading at a loss, because they just haven’t had the time to accumulate any gains. To tax loss harvest an account, you would sell the funds at a loss and realize those losses against my income (up to the $3,000 annual limit) or against any other gains I have realized in my portfolio (unlimited). You also have an unlimited carry forward on capital losses that are realized, meaning if I sold investments that had $6,000 worth of losses and no gains to report in a year, I could realize $3,000 in losses in this year and $3,000 in losses in the following tax year. According to Whitaker-Myers Tax Advisors CPA Kage Rush, “Tax Loss Harvesting is an optimal strategy during periods of market declines and can reduce your tax liability or increase your refund, while keeping your money still invested for the eventual market recovery. With a firm like Whitaker-Myers, where we can incorporate tax planning, financial planning and investment management, these types of opportunities can be uncovered and executed.”
Won’t I Miss the Eventual Stock Market Recovery?
Warren Buffet said it best, “Buy low and sell high”. Data suggests that most investors, “buy high and sell low”. Ouch! When we describe a scenario like the one above, where an investor sells their investment to realize a loss and generate tax benefits for themselves, doesn’t that mean that I, the investor, miss the eventual recovery? The answer to that question (at least within Whitaker-Myers) is NO! The reason being is when an investment is sold to create the tax loss, we then simultaneously buy a similar type of investment, to ensure the portfolio is still optimally built around the risk tolerance of the client and to avoid the most common investor mistake: Buy high, sell low. Effectively, what you’re doing is selling low, to create the tax benefit, while also buying low, to ensure you don’t miss the eventual bounce.
Wash-Sale Rule
One thing that needs to be understood and planned around is the IRS Rule around wash-sales. The IRS doesn’t want you selling an investment and then buying a “substantially identical” stock or security within thirty days. If your transaction is deemed by the IRS to be a wash-sale then the losses could be made null and void (in terms of offsetting income or gains) and if severe enough the IRS could restrict trading and/or place fines on your account. This is why the tax loss harvesting should be done with the help of your Financial Planner.
Client Example
To help your understanding of how tax loss harvesting works, let’s use a hypothetical client example:
Suzie Jones starts investing with her Financial Advisor on 1/1/2022 and we can see from this chart here, that the S&P 500 is now down 21% YTD (7/14/2022). That means if she invested $100,000, her current balance would be approx. $79,000 (she has a 21,000 unrealized loss).
Let’s examine how Suzie would realize these losses while still staying invested
Suzie sells her S&P 500 fund to realize the loss
Suzie with her Financial Advisor simultaneously buys another security that doesn’t trigger wash sale rules.
Suzie has another investment that has a short-term gain of $6,000 which is offset by this sale, meaning she no longer has to pay tax on this gain, thereby saving her income taxes on the gain.
This leaves Suzie with a net loss of $15,000. She is only able to realize $3,000 per year against her income with unlimited carry forward. Suzie should be able to reduce her income by $3,000 in 2022, 2023, 2024, 2025 and 2026.
If Suzie were in the 22% Federal Tax Bracket the tax loss harvesting has saved $660 in taxes each year and $1,100 against her short-term gain mentioned above, providing a total tax savings of $4,400.
When the market recovers and Suzie’s account is net positive again she would still be receiving tax benefits from when the market fell – win, win, win!
Talk to your Financial Planner and Tax ELP
Every situation is unique and the information provided in this article is for educational purposes only, however if you have a Schwab One Brokerage (Dave Ramsey calls these Bridge Accounts) than it is entirely possible this strategy is worth looking into. If you’re in Baby Step 7 and you haven’t set up your brokerage account yet, to start paying your house payment to yourself, now may be the perfect time to do so, allowing you to participate in this strategy in the future. Please contact our Tax Endorsed Local Provider on staff by clicking here or your Financial Planner by clicking here.