Turkeys, briskets, and hams aren’t the only feasts on the table this holiday season. Investors are hungrily eyeing a bounty of tax loss harvesting opportunities from an underperforming stock market. Yes, Virginia, there is a Santa Claus. His name is Jerome Powell. He and his seven reindeer, aka Fed governors, have given us the gift of tax-deductible losses this year.
This isn’t for everyone. Active investors who minimized drawdown during 2022 might not see a box under their holiday tree. Many of them need to pay taxes on realized gains this year. On the other hand, passive investors should be able to reap the rewards of watching their retirement savings dwindle away. Be joyful! Your losses will minimize your tax liability!
In the spirit of the holidays, we’ll give the Fed a partial pass on this one. Higher interest rates are only one factor that fueled the downtrends in market equities this year. Supply chain problems, global conflict, and the persistence of Covid-19 variants have done their part. We also had several overvaluations from 2021 that have since corrected themselves.
What is Tax Loss Harvesting?
Tax loss harvesting is essentially “selling the dogs.” This is done to lock in market losses that can offset taxable gains. It can happen anytime during the year, but most financial advisors and seasoned investors do it during the holiday season. There’s something special about lowering your tax liability while you’re spending money on holiday gifts.
We’ve just been through months of significant losses across all sectors, so choosing which securities to offload during harvest season is a more difficult task this year. You may be attached to those “core holdings” that have been perennial mainstays in your portfolio. What does their recent performance look like? It might be time to move on.
The traditional view on tax loss harvesting is to use the proceeds from selling a security at a net loss to purchase a “similar” security to keep the portfolio “properly balanced.” Read that sentence a few times. Does it make sense to you? Doing the same thing and expecting different results is the very definition of insanity. Why not buy an entirely different asset?
The Wash-Sale Rule and the $3,000 Limit
You might think, “I’ll sell it, take the loss, then buy it right back.” Aside from that obsessive-compulsive disorder (OCD) in action, it’s also illegal. IRS regulations prohibit sellers from buying back the same stock within thirty days. It’s called the Wash-Sale Rule, and it only applies to equities. Cryptocurrencies and ETFs can be sold and bought on the same day.
Do you see a window of opportunity with your crypto losses? Unfortunately, the IRS puts a $3,000 cap on what you can take in losses against your realized capital gains. You might want to keep your Ethereum for a while longer.
There are consequences if a loss is disallowed by the IRS for violating the Wash-Sale Rule. The taxpayer is unlikely to get fined, but they will need to add the loss to the cost of the new stock, which becomes the cost basis. To avoid that, have a financial advisor handle your harvesting, or simply don’t buy anything new after you sell. Cash is a position also.
Tactive Advisors do this Year Round
Tax loss harvesting is more complicated when you’re an active trader. Managing downside volatility means you’re selling poor performers year-round. Capital gains could remain unrealized if you don’t liquidate those positions. Tactive advisors always pay attention to this, not just in December. Tax planning is part of investment management. Reach out to your Tactive advisor today to learn more about this.
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