The financial services industry has no shortage of buzz words or phrases. Tax loss harvesting sits near the top of the list. Some money managers use it as a marketing strategy. While it is definitely a stretch to lead your marketing campaign to manage people’s money with tax losses, it can save investors a lot of money in tax dollars. Simply put, tax loss harvesting is taking losses to offset capital gains. It is more complex in that there are rules to follow, and you can certainly make some costly mistakes if you don’t follow them.

Let’s start with understanding how capital gains are taxed. The long-term capital gains rate for 2023 is 0% for single filers with $44,625 or less in taxable income and married couples filing jointly with taxable income of $89,250. It is 15% for single filers with taxable income up to $492,300 and married couples with taxable income up to $553,850. It is 20% for taxable incomes above those limits. You must hold a position for more than one year to receive long-term capital gains tax treatment. Anything under a year is a short-term gain and is taxed at your income tax rate. If you are retired and have a low taxable income, you may be able to keep your capital gains tax free or at least at the 15% rate. These limits should obviously be factored into any decisions you make with your portfolio.

Now that you know the tax rates, you need to know the rules. If you are taking a loss in a fund and buying another fund, you have to make sure that it is not a “substantially identical” fund. You can’t buy the same holding back for 30 calendar days or the loss is not realized. You also have to understand that only $3,000 can be used against earned income. If your losses exceed your gains plus $3,000, then you can carry the loss and use it in future years. We strongly recommend that you consult with a professional before taking any action.

It is very difficult to walk the line of locking in a tax loss and waiting the 30 days to buy it back vs. keeping the holding and dealing with the taxes you’ve accumulated from other holdings. This is particularly difficult with individual stocks. If the stock has a sharp upward move in the 30-day period, then you are stuck playing the fun game of determining when to get back in. If you are ready to part ways with a stock for good, then it is a much easier decision.

With funds, you have some more flexibility. You can sell one fund and buy another simultaneously and maintain your investment strategy. It can be very effective, especially in a down year. You just have to make sure that the fund is not considered substantially identical. Fortunately, that rule is not very stringent currently, but we still recommend evaluating this with a professional.  

If you are fortunate enough to have enough income and earnings to worry about capital gains taxes, tax loss harvesting is something you and your financial professional should consider. As always, you have to ensure that you aren’t making short term decisions that can impact your long term plans. However, if there is an opportunity to lower your taxes and stay on track, then you should take advantage of it. Remember, it’s not what you make, it’s what you keep.

Disclosures