Tax Loss Harvesting – A 2016 Investor’s Guide

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Got unrealized capital losses? It’s time to brush up on your tax loss harvesting knowledge and skills because 2015 is shaping up to be the worst year for stocks since 2011.

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Of course “worst year” is a relative term. In the aggregate, stocks are looking to end up flat to slightly positive on the year. But in a year where some stocks, mutual funds, and ETFs will have gains while others will see losses, tax loss harvesting can be a smart idea for many investors.

For investors with taxable brokerage accounts, tax loss harvesting is an integral and controllable aspect of higher net returns in the long run. That is, for smart investors who count taxes as one of the costs of investing, it is important to know when and how to minimize taxes on capital gains.

So if you’re new to tax loss harvesting, or you just need to review the basics before buying and selling securities in your taxable account portfolio, we put together this quick and dirty guide.

The Basics on Tax Loss Harvesting

Tax loss harvesting can be described simply as the act of selling a security with a loss and selling a security with a gain for the purpose of reducing capital gains taxes. Keep in mind that you don’t truly have a gain or a loss on any asset until you “realize” the gain or loss by selling the securities. Until you realize the gain or loss, you just have something on paper or online telling you how much the securities are worth.

For example, if you sell your stock, mutual fund, or ETF for a higher price than you bought it, you will generally have a capital gain. If you sell your stock or fund for a lower price than you bought it, you may have a capital loss.

By realizing, or “harvesting” a loss, investors are able to offset taxes on gains and possibly income as well. If net losses exceed $3,000 an investor can carry forward any unused losses into a future tax year. Investors can also use up to $3,000 to reduce regular income.

Securities that are sold can be replaced by similar ones for the purpose of maintaining the investor’s target asset allocation and the expected returns. But be sure to read our “cautions and tips” on this later in this article.

 

Who Benefits Most From Tax Loss Harvesting

Remember that capital gains or losses do not apply to tax-deferred accounts, such as a 401(k) or IRA, so tax loss harvesting is not possible in these types of accounts.

In 2015, investors in the 10% and 15% tax bracket are eligible for the 0% capital-gains rate for securities held for more than one year (long-term capital gain). Therefore if you are single and your taxable income is $37,451 or less, or $74,900 or less if you are married filing jointly, tax loss harvesting may not necessary, unless you expect to be in a higher tax bracket within the next few years and you want to keep capital gains to a minimum now.

Taxpayers in higher tax brackets can benefit the most from tax loss harvesting. Those in the 25% to 35% brackets will be subject to a 15% long-term capital gains rate. So, 2015, this rate will apply to single filers with taxable income between $37,451 to $90,750 and married filing jointly taxable income between $74,901 and $151,200.

Tax loss harvesting is particularly important to taxpayers in the 39.6% tax bracket (income over $413,201 for singles;  for married couples), because they face taxes of up to 23.8% on dividends and long-term capital gains, not the 15% rate that applies to most investors.

Cautions and Tips on Tax Loss Harvesting

Some investors like to buy back the same security they sold (harvested) at a later date. Before doing this be aware of the IRS Wash Sale Rule, which essentially says that an investor cannot buy a substantially equal security within 30 days, before or after the sale, when the sold security is used to offset gains. However, there is no concrete IRS definition of “substantially equal security.”

A smart way to avoid the Wash Sale Rule is to buy an ETF that tracks similar securities that you sold. For example, if you sold some large-cap stocks that have losses in 2015, such as Exxon Mobil (XOM) or Berkshire Hathaway (BRK.A, BRK.B), you could temporarily replace them with a large-cap index ETF like SPDR S&P 500 (SPY), which includes both of those stocks as top holdings, along with hundreds of other large-cap stocks.

Finally, tax loss harvesting can be a smart tax-saving strategy but it is rarely a good idea to allow tax management to dictate portfolio management and investment strategies. But if you’re already considering selling appreciated securities or other assets in 2015, cutting them loose by year-end could save you money.

Above all, be sure to talk to a tax professional if you are considering tax loss harvesting in 2015.

As of this writing, Kent Thune did not personally hold a position in any of the aforementioned securities. His No. 1 holding is his privately held investment advisory firm in Hilton Head Island, SC. This information is intended solely for discussion purposes and it does not represent a recommendation to buy or sell securities.


Article printed from InvestorPlace Media, https://investorplace.com/2015/11/tax-loss-harvesting-investors-guide/.

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