Tax Loss Harvesting and Its Impact on Your Portfolio
by: Alissa Shawl
Let's face it. Not all investments (individual stocks, bonds, gold, etc.) or asset classes (U.S., International, or Emerging Markets, for example), go up in value at the same time.
It's natural to experience some level of frustration from investments that have depreciated in value, but as with any loss, there is always the potential for an opportunity.
Tax-loss harvesting is one opportunity that can benefit your overall portfolio (and your wallet)
when a capital loss occurs in your portfolio. Unfortunately, many investors (or their advisor) fail
to act on it.
The chart below depicts an example of utilizing a capital loss to offset a capital gain, and the potential benefit that could occur as a result, including the offset of a portion of ordinary income.
This example assumes a 20% combined federal/state marginal income tax bracket. The example is hypothetical and provided for illustrative purposes only. It is not intended to represent a specific investment product and the example does not reflect the effects of fees.
Source: Schwab Center for Financial Research with changes made to suit our specific example.
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Did you know that long-term gains and short-term gains are taxed at different rates for federal purposes? Long-term gains receive a preferred tax rate, while short-term gains are taxed at ordinary tax rates. Tax loss harvesting can provide an advantage here as well. Let's assume the $20,000 gain in the earlier example was short-term (the asset was held for less than one year).
The net capital loss, either long or short, can negate the short-term gain savings even more in income tax.
With the proceeds derived from the sale of the investment (an individual security, a mutual fund, or an exchange traded fund) with a capital loss, you can potentially create another opportunity - a chance to rebalance. Alternatively, if you really want to maintain a position within the same asset class, you could purchase another asset that is not "substantially identical" for at least (31) days as to avoid the IRS "wash-sale rule."
Ultimately, tax-loss harvesting can provide many benefits if techniques are employed properly. To review, those benefits include lowering capital gains tax owed, reducing ordinary income tax due, and providing opportunities for rebalancing toward one's asset allocation. Not only can this process potentially increase cash flow in the short-term, but has the ability to create better tax-adjusted returns over the long-term.
If you have any questions about how tax-loss harvesting can benefit your portfolio, please reach out to your advisor.
Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as investment, tax or legal advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon when coordinated with individual professional advice.
