[IMGCAP(1)]Investors have been taught by our elders since time immemorial to live by the adage, “Buy low, sell high.”
No matter how sophisticated the synthetic securities dreamt up by our investment banking brethren get, this still rings true today. But we don’t always get what we want, and (often) find ourselves holding securities at a loss. But do not despair. There are some positives that can be had from holding these losses. That would come from tax-loss harvesting.
Tax-loss harvesting is the selling of investments held at a loss to offset gains from investments that were sold for a gain. It reduces the impact of capital gains taxes and reduces, within limit, ordinary income taxes.
Tax-loss harvesting is potentially advantageous for all investors, but particularly for those who were thinking about selling investments held for a loss anyway. It is especially important for high-net-worth individuals because the capital gain rate for top earners is not 20 percent, but 23.8 percent because of the net investment income tax.
Sales, for this purpose, must be made during the same tax year (generally calendar year for individuals), but can be done anytime during the year, not just at year end.
Tax-loss harvesting is not risk free. There are two potential drawbacks. One is that you must abide by the wash sale rule, meaning you cannot buy back the substantially same investment that you sold for the loss within 30 days either before or after the sale. And this applies to all accounts held by the taxpayer, even IRAs.
Two is that when you reinvest the proceeds of the sale, you are reinvesting at a lower basis than you originally had with a new holding period. So you will have a larger capital gain in the future when you sell that investment. Not a big deal if capital gains rates stay the same, or drop, but if capital gains rates rise, then you lose the benefit of tax harvesting today (not taking into account the time value of money).
A new holding period also means that, if you have to sell the new investment within a year, you will be taxed at ordinary income tax rates, rather than capital gains rates, i.e., you have effectively caused the tax rate on capital investments to rise.
All our stocks should rise, but if they don’t, tax-loss harvesting can take some of the edge off of the loss.
Michael Sonnenblick, J.D., LL.M., currently serves as an editor/author with Thomson Reuters Checkpoint with the Tax & Accounting business of Thomson Reuters. Michael holds a J.D. degree from Boston University School of Law and an LL.M. in Taxation from New York University Law School. A member of the New York Bar, Michael has 20 years of tax experience, including service with a major Wall Street bank and international law firms. In addition, he has represented clients before the IRS. Michael’s specialties include individual taxation and retirement planning.
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