By John P. Napolitano, CFP®, CPA, PFS, MST

The term itself doesn’t sound very appealing. Afterall, we invest for gains so who would want to harvest losses?

But every investor knows that investments do two things. They rise and they fall. The process of selling an investment that has lost value will allow you to either reduce your taxable income by up to $3,000 or offset future gains. Any excess losses can be carried forward to a future tax year when you may be able to create gains.

Doing tax loss harvesting is not a market timing maneuver, it’s more of a tax smart way of investing. In theory, you would sell investment X today at a loss and buy a very similar investment B tomorrow. You cannot buy the same exact investment for another 30 days because of the IRA ‘wash sale’ rules. The wash sale rules would prevent you from utilizing the loss from the sale if you repurchased the same security within 30 days. If you wait 31 days you are ok, but that means that you’re out of the markets for at least 30 days.

To avoid the wash sale rule you would simply exchange the sold position with another financial product that has a very similar investment philosophy. This is easy if you are working with large funds or ETF’s, and hard to replicate if you are working with individual securities.

To create the loss you must actually sell the position. Just because the investment is worth less doesn’t trigger the ‘loss’ for tax purposes. Tax loss harvesting would not apply inside retirement accounts.  Whether it is an IRA, 401K, SEP or any qualified retirement plan, taxation is not an issue until you withdraw money from that account. And upon withdrawal, it all comes out as ordinary income.  There are no capital gains and losses inside retirement accounts.

The hardest part is keeping an eye out for these opportunities. Many investors have the bad habit of not looking at their portfolios when things are down. They frequently miss the opportunity for tax loss harvesting. If you’re paying for an advisor, they’re the ones that should be on the lookout for tax loss harvesting opportunities.

Materiality is also a consideration in your loss harvesting strategy. You need to decide how small is too small. You don’t want to buy and sell every time there is a little dip in markets. You’ll drive yourself crazy tracking it and then again when it comes time to file your taxes.

Along with a regular tax loss harvesting mentality, do not let capital loss carryovers sit around too long.  Not that it’s a bad thing to save them for future gains, but I find that when people let them sit forever they kind of forget about them. This may be particularly problematic for the taxpayer that does their own tax returns.

As it relates to 2020, we may have passed the best opportunity for tax loss harvesting. But given the wacky nature of this year and the upcoming elections, pay attention. You may have an opportunity yet to harvest some losses in 2020.

 

John P. Napolitano CFP®, CPA is CEO of US Wealth Management in Braintree, MA. Visit JohnPNapolitano on LinkedIn or uswealthnapolitano.com. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. US Wealth Management, US Financial Advisors and LPL Financial do not offer tax advice. John Napolitano is a registered principal with and securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through US Financial Advisors, a Registered Investment Advisor. US Financial Advisors and US Wealth Management are separate entities from LPL Financial. He can be reached at 781-849-9200.

1-05054065 (9/18/20)