The holiday season is officially underway! And everybody is in preparation mode.
With shopping, traveling, party planning, and so forth… probably the last thing anyone wants to think about right now is tax season.
After all, the dreaded filing deadline is still months away, right?
But (as of last year), the times have changed—specifically, federal tax rules. Taxpayers (and particularly married taxpayers) now have a higher standard deduction.
That’s why, as we approach the end of the fiscal year, it’s a good time to look at ways to save on your tax bill.
One of the simplest is tax-loss harvesting.
Tax loss harvesting is the practice of selling a security that has declined in value since you bought it.
Losses are valuable for taxable accounts. By booking a loss, investors can offset taxes on both gains and income by as much as $3,000 per year. And if you have more than $3,000 in losses, don’t worry: unused losses can be carried forward to be used next year (and even after that).
But be careful if you sell a security that you might want to buy back.
A wash-sale rule was created to make sure investors don’t sell a security for a tax benefit, only to turn around and buy it again. The rule states that in order to be treated as a tax loss, no identical or nearly identical security (like ETFs and mutual funds with similar holdings) may be bought within 30 calendar days before or after the sale—otherwise, a tax loss will be disallowed.
For example, if you sold IBM for a loss, you should wait 30 days before buying it again. If you don’t, you’ll lose the tax-related advantages of the loss you took on this position. You also cannot buy IBM ahead of a planned sale—the 30-day wash-sale window applies to both the pre- and post-sell date.
The wash-sale rule applies across all accounts, including the tax-deferred ones. For instance, you can’t sell IBM in your taxable account and immediately add it to your IRA. You’d need to wait at least the full 30 days, regardless of the account you’re using.
All that said… it’s been a very strong year, with stock indices gaining 20% or more. Plus, we’ve been in a major bull market for 10 years. As such, investors might not have too many losses to book.
Many investors are instead sitting on a significant amount of unrealized capital gains.
If that’s the case, investors might want to harvest their capital gains through year-end.
Capital gain harvesting is the opposite of harvesting capital losses. That might sound counterintuitive—why book a gain and pay taxes prematurely? But this technique could be useful for those who find themselves in a lower tax bracket for the year, or plan to itemize deductions.
Think about tax-gain harvesting as a technique of moving the gains into the year you can best afford them.
Don’t forget to talk to your accountant. A professional who knows your situation should be able to provide much more specific advice.
If you decide to harvest losses or gains, though, don’t wait too long: only trades made in 2019 will count toward the annual tally.
Here’s one final tip: don’t sell a position just for the sake of taxes. As important as your tax planning is, it should supplement—not replace—your main investment strategy.
To a healthy portfolio,
Editor, Moneyflow Trader