Reap What You Sow: What Is Tax-Loss Harvesting?

by | Nov 7, 2019 | Newsletters

Tax-loss harvesting is a term used in the financial world that describes an interesting tax savings strategy. It can often be a confusing concept so let’s start with the definition of harvest. Harvest is the process of gathering crops after they have ripened and are ready to be picked. The crops are then stored in a silo for future use to provide food during a time when it is not readily available.

So how can a farming concept help to reduce taxes? Let’s take the concept of the harvest out of the farm and “plant” it right in the middle of Wall Street to better explain how tax-loss harvesting works. It’s a strategy that allows an investor to offset gains that they have realized in one investment with losses they have incurred with another investment.  If you own an investment that increases in value, you have a capital gain. If you own an investment that decreases in value, you have a capital loss. Any investments you currently own have “unrealized” gains or losses- you have either made or lost money on paper. Once you sell an investment you will have a “realized” gain or loss. If you have realized gains, you will owe taxes, however, if you sell an investment for a loss, that gain can be reduced or even wiped out completely depending on how much it is, which then reduces your tax liability overall. The strategy of tax-loss harvesting, however, harvests losses as they incur, to store them up in your “silo” to use against any future gains.  This only works in a taxable account and does not benefit you in a retirement account.

Here is an example of what this looks like:

Tax Loss Harvesting

There are a lot of moving parts to consider, so it is important to consult a tax professional before you harvest.  If you are to attempt this, there are some important things that you will need to understand prior. Understanding of the wash sale:  If you sell an investment for a loss, you cannot purchase that same investment (or one that is highly correlated) back within 30 days of that sale, otherwise it is considered a Wash Sale; your loss gets washed away, which means you can’t claim the loss.  Another important concept to understand is short term vs. long term investments.  Short term investments are investments owned for less than one year and are taxed as ordinary income, while long term investments are held for a year or more and have a different tax rate (either 0%, 15%, or 20% depending on your tax bracket, which may be lower than your income tax rate).  Short term losses first offset short term gains, and long-term losses offset long term gains.  Then you can offset any short-term gain with a long-term loss after all long-term gains have been offset.  Like I said- a lot of moving parts. 

Market volatility is inevitable.  At Spotlight Asset Group, we take advantage of the volatility and we harvest losses opportunistically. As losses are realized and then immediately reinvested, we are lowering your cost basis and buying securities at a lower price in order to take advantage of the market rebound. If you are in the market for the long run and have a proper allocation in place that fits your long-term goals and financial needs, taking advantage of this strategy may add value to your bottom line and more money in your pocket.

Kristin Sweis

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Reap What You Sow: What Is Tax-Loss Harvesting?

by | Nov 7, 2019 | Newsletters

Tax-loss harvesting is a term used in the financial world that describes an interesting tax savings strategy. It can often be a confusing concept so let’s start with the definition of harvest. Harvest is the process of gathering crops after they have ripened and are ready to be picked. The crops are then stored in a silo for future use to provide food during a time when it is not readily available.

So how can a farming concept help to reduce taxes? Let’s take the concept of the harvest out of the farm and “plant” it right in the middle of Wall Street to better explain how tax-loss harvesting works. It’s a strategy that allows an investor to offset gains that they have realized in one investment with losses they have incurred with another investment. If you own an investment that increases in value, you have a capital gain. If you own an investment that decreases in value, you have a capital loss. Any investments you currently own have “unrealized” gains or losses- you have either made or lost money on paper. Once you sell an investment you will have a “realized” gain or loss. If you have realized gains, you will owe taxes, however, if you sell an investment for a loss, that gain can be reduced or even wiped out completely depending on how much it is, which then reduces your tax liability overall. The strategy of tax-loss harvesting, however, harvests losses as they incur, to store them up in your “silo” to use against any future gains. This only works in a taxable account and does not benefit you in a retirement account.

Here is an example of what this looks like:

Tax Loss Harvesting

There are a lot of moving parts to consider, so it is important to consult a tax professional before you harvest. If you are to attempt this, there are some important things that you will need to understand prior. Understanding of the wash sale: If you sell an investment for a loss, you cannot purchase that same investment (or one that is highly correlated) back within 30 days of that sale, otherwise it is considered a Wash Sale; your loss gets washed away, which means you can’t claim the loss. Another important concept to understand is short term vs. long term investments. Short term investments are investments owned for less than one year and are taxed as ordinary income, while long term investments are held for a year or more and have a different tax rate (either 0%, 15%, or 20% depending on your tax bracket, which may be lower than your income tax rate). Short term losses first offset short term gains, and long-term losses offset long term gains. Then you can offset any short-term gain with a long-term loss after all long-term gains have been offset. Like I said- a lot of moving parts.

Market volatility is inevitable. At Spotlight Asset Group, we take advantage of the volatility and we harvest losses opportunistically. As losses are realized and then immediately reinvested, we are lowering your cost basis and buying securities at a lower price in order to take advantage of the market rebound. If you are in the market for the long run and have a proper allocation in place that fits your long-term goals and financial needs, taking advantage of this strategy may add value to your bottom line and more money in your pocket.

Kristin Sweis

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