TAXTEMBER: Tax Loss Harvesting

TAXTEMBER: Tax Loss Harvesting

September 26, 2022

This week for Taxtember we are going review Tax Loss Harvesting (TLH) strategy.  Another name for TLH could be “making lemonade from lemons” since you are implementing this strategy when the market falls.  This past year has been that type of opportunity.  The market peaked on January 4th and then started a downward trajectory. 

The definition of TLH is the practice of selling a security that has experienced a loss. By realizing, or "harvesting" a loss, investors are able to offset taxes on both capital gains and income. The sold security is replaced by a similar one, maintaining an optimal asset allocation and expected returns.

For example in a taxable account (not an IRA, ROTH, 401k), we had a position in the Vanguard S&P 500 ETF that was bought for $60,000 a few years ago and was trading around $40,000 in the middle of June.  We sold this position to recognize the loss of -$20,000.  At the same time, we purchased $40,000 of a Schwab Large Cap ETF to keep our equity exposure the same.  We are not allowed to buy for 30 days the Vanguard ETF (or a similar S&P 500 fund) since it can’t be an identical purchase per the IRS Wash Sales rule.  (The classic example is to sell Coca-Cola and buy Pepsi.)  We just did it with different indexes.

Now we have a -$20,000 long term loss that can help reduce our 2022 taxes.  If we sell a Mid Cap ETF in September for a +$15,000 long term gain in the account, we can match that gain (+$15,000)  against our long term losses (-$20,000) and pay no capital gain taxes and still have -$5,000 in losses yet to use.  That offset saved us $2,250 in Federal capital gains tax ($15,000 x 15%).  We can then use $3,000 of our loss to reduce our income for 2022 and then carry over -$2,000 to be used in 2023.  Even if we did not do an offset in 2022, long term capital losses can be carried over year after year until fully used.

Another way to use the TLH is if you typically get a notice of an annual capital gains distribution each December from your mutual fund company (even though you did not sell the fund).  So, your broker should have harvested losses back this spring to offset those gains that you will be getting in December. 

Or, maybe you took advantage of the hot real estate market this year and sold a property (not your home residence) and have a long term capital gain.  You can use the capital losses from your stock portfolio to do an offset which will save you taxes.