Lower Your Tax Bill: How Your Investment Portfolio Can Help
Harvesting Tax Losses Can Help Lower Your Tax Bill
Take Steps Avoid Violating Wash Sale Rules
Review Your Specific Situation and Consult with a Tax Advisor Prior to Taking Action
Most people I know would like to pay less in taxes, but many people do not realize that there are steps they can take in their investment portfolio to help achieve that goal. Last week, we conducted tax-loss harvesting for our clients. This involves selling investments that are trading below what an investor paid for them (taxable accounts only) to generate a tax loss. This can offset capital gains for the year, reduce taxable ordinary income by up to $3,000, and if there are losses still left over, carried forward to be used the next tax year. Given the strong performance in the stock market so far this year, most investors do not have oodles of losses, but that potentially makes harvesting losses that are available more useful in order to offset to any current year gains.
Capital Gains Refresher
When an investment is sold in a taxable account, investors must pay taxes on the difference between the purchase price and the sale price. This difference is called a capital gain and it is categorized between short term or long term depending on how long they owned the investment. Short-term capital gains (investment held for one year or less) are taxed at a person’s regular tax rate (as ordinary income) but long-term capital gains (investment held for more than one year) are taxed at more favorable rates.
Short-term capital gains are taxed as ordinary income according to federal income tax brackets.
Short-term capital gains are taxed as ordinary income according to federal income tax brackets.
How Tax-Loss Harvesting Works
Let’s assume an investor has $10,000 in long-term capital gains so far in 2020. Further, let’s assume they are married and filing jointly with an income of $100,000. That means capital gains will be applied at the 15% rate and their tax bill will increase by $10,000 X 15% = $1,500.
That investor may want to look through their portfolio to see if they have any losses to be harvested. Let’s assume they purchased a stock of a company that has had a rough year (it happens!) and the value has dropped by $5,000 since purchasing it a year and a half ago. The investor could sell that stock to lock in a $5,000 loss. This would offset their capital gains so they would now only owe taxes on $10,000 - $5,000 = $5,000 in capital gains. The new tax bill is therefore $5,000 X 15% = $750. A savings of $750.
If the investor had realized losses in excess of gains, they could use up to $3,000 of losses to offset ordinary income further lowering their tax bill. Anything above that can be carried forward to be used the next year (remember rollover minutes on cell phone plans?).
Tax Loss Carryforward.
Avoiding the Wash Sale
The IRS has rules governing this practice called Wash Sale rules. They state that an investor cannot claim a loss for tax purposes if they have bought a “substantially identical” security within 30 days of the sale (before or after). At Aurora, we use software designed to help us avoid this issue for our clients. We also use the tax loss proceeds to buy securities that we expect to provide clients with market exposure while we wait out the 30-day window. After that, we have the option to swap back into the original security.
Concluding Thoughts
Tax-loss harvesting is one of the many ways we look to add value for our clients. If you have concerns about your specific situation, please reach out and we will develop a tax-loss harvesting plan specific to you. This is especially important if you have gains/losses from accounts not held at Aurora that need to be considered. For readers looking to employ tax-loss harvesting strategies on their own, be sure to thoroughly review Wash Sale Rules, Capital Gains Rates, and consult with your tax advisor.
Invest Curiously,
Austin Crites, CFA
Austin Crites is the Chief Investment Officer of Aurora Financial Strategies, a financial advisory firm based out of Kokomo, IN. He can be reached via email at austin@auroramgt.com. Investment Advisory Services are offered through BCGM Wealth Management, LLC, a SEC registered investment adviser. This blog does not constitute advice. This is not an offer to buy or sell securities. Advisor is not licensed in all states. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. BCGM Wealth Management, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Investors may lose all of their investments. Past performance is not indicative of current or future performance and is not a guarantee. The information set forth herein was obtained from sources which we believe to be reliable, but we do not guarantee its accuracy. In preparing these materials, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public and internal sources. Aurora Financial Strategies and BCGM Wealth Management, LLC shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them. Clients may own positions in the securities discussed. Aurora Financial Strategies & BCGM Wealth Management, LLC Advisors do not provide tax or legal advice. This material was not intended or written to be used or presented to any entity as tax advice or tax information. Tax laws vary based on the client’s individual circumstances and can change at any time without notice. Clients are urged to consult their tax or legal advisor before establishing a retirement plan.
