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Tax Loss Harvesting

Last year was unusual. The US stock market posted positive returns every single month and other stock markets around the world also posted strong returns. This year has been more “normal” as we’ve seen some months with strong returns and some with losses. Some asset classes, like international stocks, are now down significantly on the year. Unfortunately, these losses feel worse than the gains we previously experienced, a concept called loss aversion first identified by the brilliant Amos Tversky and Daniel Kahneman.

We can do everything possible to try to prepare ourselves for losses. We can tell ourselves the market can’t always go up. We can remind ourselves we have a financial plan in place and don’t have to worry about the short-term market fluctuations. We can build a well diversified portfolio and rebalance regularly. But none of these things will truly make us feel better when we see our accounts drop in value. The only real way to avoid these feelings is to not pay any attention to what the markets are doing, but in this day and age that’s a tough task.

There is, however, one benefit to a falling market - the ability to trigger unrealized losses for tax purposes, something we call “tax loss harvesting”. If you have any investments that have lost value since you purchased them, you can sell that investment to generate a capital loss, which can be used to offset any capital gains on your tax return. If you don’t have any capital gains you can take up to $3,000 of losses against other income and carryover the rest of the loss to future years.

The IRS does have rules in place to prevent you from selling an investment just to realize a loss for tax purposes. Under the “wash sale” rules, you are unable to repurchase the investment you just sold, or a “substantially identical” investment for 30 days. This means you would miss out on any gains (or potentially avoid losses) on that investment for the 30 day period.

Fortunately, there is a way to still harvest your losses without having to stay out of the market for 30 days, especially if you primarily own broad based asset class funds. Let’s say you own an actively managed international stock mutual fund that is currently showing a loss. You could sell that fund, trigger the loss, and purchase an international stock index ETF. While the returns on the new investment won’t exactly match those of the fund you sold, you will still be exposed to that asset class for the 30 day period. After that time is up you can decide whether you want to sell the temporary holding and move back into the original fund, or just keep the new ETF.

While the tax benefit from harvesting losses won’t make up for the lost value in your portfolio, it might soften the blow a little bit. We go through this exercise for our investment management clients when we find holdings that have unrealized losses. In recent weeks we’ve been able to harvest losses in many client accounts that will generate tax savings for those clients. We also work closely with outside managers to make sure losses are harvested in those accounts.

If you would like to learn more about tax loss harvesting or how we help clients manage their portfolios, feel free to reach out to me anytime.

-Chris Benson, CPA, PFS

The views expressed represent the opinions of L.K. Benson & Company and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person. Please see Additional Disclosures more information.