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Harvesting Year-End Tax Losses - What To Know?

Harvesting Year-End Tax Losses - What To Know?

December 21, 2023

Why Harvest Tax Losses?

Managing tax losses can be challenging because, first of all, no one likes to hear about losses, tax or otherwise. And secondly, a high level of understanding of investments and taxes is required. However, analyzing your investment holdings (stocks, mutual funds, ETFs) could save capital gain and ordinary income taxes.

Tax loss harvesting is a strategy to sell stocks or other investment assets that have declined in value to generate capital losses. You can harvest tax losses to offset taxable capital gains, take advantage of the $3,000 deduction against ordinary income, or generate carryforwards to use in a future tax year.

For example, in 2023, you sold a bond mutual fund that had lost value since its purchase. The loss incurred on the bond fund sale can offset dollar for dollar any capital gains incurred. If any losses remain after offsetting the gains, a deduction of $3,000 against ordinary income is allowed.


Taxable Account v. Qualified (Non-taxable account)

Using capital losses to offset capital gains only works for taxable accounts, such as individual, joint, trust, and other accounts not receiving tax deferral treatment on dividends, interest, and capital gains.
 Individual Retirement Accounts, 401(K)s, 403(B)s, and other tax-deferred accounts do not report such income to the account owner until funds are withdrawn, which will be taxed at ordinary tax rates regardless of its original character – dividends, interest, or capital gains.

 For example, Jenny has an IRA and a taxable brokerage account. She made several transactions during 2023 in both the qualified IRA and the taxable account. Any gains, losses, dividends, and interest incurred in the IRA are not reported as income (or loss) to the account owner. However, the gains and losses from Jenny’s taxable brokerage account will be reported to her.

How To Find Gains and Losses
Your custodian or brokerage should be able to provide a statement that provides Cost Basis/Unrealized Gains & Losses. Below is an example of the information typically listed on a cost-basis statement.  

A. Acquired/Opened
The date the security was purchased, gifted, exchanged, or inherited. The acquisition date is required to determine whether a realized gain or loss is considered a short or long-term investment.

B. Market Value
The current value of a security is the market value. The market value is readily available and updated continuously if the investment is listed on a public exchange. Your brokerage or custodian can provide the value, or you can usually retrieve the information online.

C. Cost Basis
The most important number to calculate in the analysis is the investment's cost basis. The brokerage or custodian of your taxable accounts should be able to provide the cost basis calculation for each of your securities, and depending on the brokerage, it should be available online. The cost basis includes more than just the original cost of the investment. Increases in cost basis include:
l transactions are held for less than a year and are taxed at ordinary income tax rates.

  1. Re-invested dividends and capital gains. Many forget to include the re-invested dividends and capital gains - especially if the cost is calculated manually.

  2. The “Step-up” basis rule could increase the cost basis - certain assets get an increase in the cost basis equal to the fair market value on the date of the first spouse's death in a community property state (CA).

  3. The cost basis of inherited securities is the FMV of the security on the date of the deceased account owner.

 D.$Unrealized Gain/Loss
This is the “paper” gain or loss that the security has experienced. This amount represents the difference between the market value and the cost of the entire quantity. When the security is sold, any unrealized gain or loss is recognized. It is also possible to sell only a portion of the amount and recognize only a portion of the loss.

E. Holding Period
The length of the investment will determine whether lower tax rates can be used for capital gains. Long-term capital gain rates will apply if an asset is held for at least a year. Short-term capital transactions are held for less than a year and are taxed at ordinary income tax rates.

Planning Points/Questions

 Capital losses incurred can offset capital gains in the same year and reduce other ordinary income (wages, rents, etc.) up to $3,000.

For example, Investor X incurred $6,000 in capital losses and $2,500 in capital gains. Investor X can use the losses to offset the $2,500 of capital gains and use an additional $3,000 of the loss to reduce ordinary income. Investor X will have a $500 carry forward to the following year. See IRS Publication 550 on Capital Gains.
 However, please note that not all capital gains will be taxed. Married Filing jointly taxpayers will have a 0% capital gain provided their taxable income for that year is below $94,050 (Single $47,025). It may not make sense to sell a security at a loss and not have any capital gain to offset. But remember, even if there are no capital gains, up to $3,000 of current and carryforward losses can be used to offset ordinary income.

For the 2023 tax year, individual filers won’t pay any capital gains tax if their total taxable income is less than $44,625 ($89,250 MFJ) or less. The rate jumps to 15 percent on capital gains if their income is $44,625 to $553,850 - above that income level, the rate climbs to 20 percent.

Doesn’t Selling Underwater securities go against a Long-Term Disciplined strategy?
Selling a security whose market value is less than its cost is usually a sign of the bad habits of short-term speculation – buying on the way up and selling on the way down. However, longer-term holdings, which may play significant roles in your portfolio construction, can also have lower values depending on various factors (i.e., purchase date, recent performance). The tax benefits from a sale and repurchase of a similar investment (see wash sale) would not violate the disciplined investing strategy as the missed days out of the market could be minimal.

For example,

You sell a security XYZ, considered a U.S. Large Cap Stock, at a $3,000 loss in 2023. You must wait 30 days following a sale of a particular security to repurchase that same security (see wash sale below), but it does not prevent you from buying a similar investment, such as another stock, mutual fund, or ETF representing the U.S. large-cap asset class. Your portfolio could be rebalanced to its original allocation, and you’ve saved taxes by offsetting capital gains and taking a $3,000 maximum reduction of ordinary income.

 But note that the "wash sale" rule prevents you from using a loss for tax purposes if you repurchase the same or substantially identical securities within 30 days before or after your sale or enter into a contract to acquire such stock or securities. Ordinarily, one company's stock isn't considered substantially identical to the stock of another company for purposes of the wash sale rule.

Which investments might be showing a loss?
 Certain asset classes have had negative annualized rates of return since Oct 2020, mainly due to rising interest rates from the supply chain impediments caused by the pandemic. Unsurprisingly, the asset classes with 3-year negative returns are mostly bonds, which lose value when interest rates increase. Below is a list of asset class indexes that have lost the greatest value since Oct 2020. The list can help you identify, by description, which asset classes you have that could use some tax loss harvesting analysis.

                                                                                  Three Year
                                                                                 Annualized %
                                                                               Oct/20 – Sep/23
MSCI Emerging Markets Growth Index                     (7.19%)  Stocks
Bloomberg U.S. Treasury Bond Index                       (5.83%)  Bonds of 11 to 30 years maturities.
Bloomberg U.S. Aggregate Bond Index                     (5.21%)  Index of All Bonds – Govt, Corp, Muni, etc.
Bloomberg U.S. Corporate Bond 3-7 Yr Index          (2.47%)  Corporate bonds of intermediate maturities.

Past performance is no guarantee of future results. Non-US equity index returns are net dividends. Indices are not available for direct investment. Their performance does not reflect the expenses associated with managing an actual portfolio. MSCI data © MSCI 2023, all rights reserved. Bloomberg data provided by Bloomberg. FTSE fixed income indices © 2023 FTSE Fixed Income LLC.


What are the costs and risks of harvesting tax losses?
The direct cost will be the transaction costs of a security sale, including commissions. The main risk is that the asset will rise in value after you sell. In most cases, the savings in taxes should outweigh the potential market upswing, especially if you plan on repurchasing a similar asset to maintain your long-term disciplined strategy.

I apologize for writing this important blog post so late in the year. If you would like me to review your positions and discuss your strategies, please contact us and speak to someone right away. Feel free to review our website for more information on our financial planning and investment management services.