When the market is tumultuous – like it’s been with the coronavirus – it’s easy to get caught up in the frenzy. However, seasoned investors know to find the positive of every situation. Yes, we’re in a bear market, but opportunities may present themselves.
One option for investors to capitalize on a downturn is tax-loss harvesting. In this article, we’re going to discuss how you can utilize this tactic to your advantage.
What Is Tax-Loss Harvesting?
In a broad sense, tax-loss harvesting is when you sell shares at a loss to offset the gains in another investment.
For example, let’s say that you had two stocks that you bought for $100 each. One stock loses 30-percent while another gains 30 percent. You sell the losing stock to offset the gains of the other, effectively making your tax burden zero. There are also a few other elements to consider.
The Wash-Sale Rule
This rule exists to prevent investors from offsetting gains with a losing stock and then repurchasing it immediately. According to the IRS, you have to wait 30 days after the sale to buy back the stock.
You can “get around” this rule by buying similar stocks or ETF’s instead. For example, if you sold an S&P 500 ETF, you could turn around and buy a Russell 1000 ETF, realizing your loss while remaining invested in the market.
This is why investing in ETFs over mutual funds within Non-Qualified accounts can be advantageous – you have more control over your harvesting methods. You can trade ETFs intraday, while mutual funds are trade at end of day only.
Offsetting Non-Investment Income
Your modified adjusted gross income (MAGI) can be lowered if you contribute funds to a tax-deferred investment like a 401k. Additionally, with the help of tax-loss harvesting, you can use up to $3,000 of your losses to count against your MAGI; any losses over $3,000 in a single tax year will be carried forward indefinitely until it is used up. When a market downturn affects all of your investments, you might take advantage of tax-loss harvesting to lower your tax bill for the year.
Long-Term vs. Short-Term Investments
Short-term investments are those you’ve held for a year or less, and any capital gains on them are taxed at your regular income rate. Long-term earnings, however, are tax at capital gains rates. Losses from a long-term investment have to offset other long-term investments before being used for short-term gains, and vice-versa.
The Benefit of Tax-Loss Harvesting
The long-term goal of consistent tax-loss harvesting is to reduce the tax-drag within Non-Qualified portfolios. This can be especially beneficial for those in the highest tax-brackets. Many folks only look to loss-harvest at year-end, which can result in missed opportunities. Leveraging a professional money manager with a tax-managed mandate can help drive alpha over the long-term.
The information provided does not constitute an offer or a solicitation of an offer to buy any securities, products or services mentioned. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. Consult your financial professional before making any investment decision. Indices are unmanaged and do not incur fees, one cannot directly invest in an index.