Nobody wants to lose their shirt in the stock market, nor do they want to pay the government a ton because of capital gains, which is where tax loss harvesting comes in.
Used by all sorts of investors, tax loss harvesting is a strategy in which you offset gains in the stock market by realizing losses from other investments. While many investors will engage in this strategy near the end of the year, experts say it’s something you should be doing year round, particularly in a year like this one which has seen a lot of volatility in the stock market.
“Tax loss harvesting is not a fourth quarter sport,” says John Sweeney, executive vice president at Fidelity Investments. “It’s a year round activity. The market moves up and down all year.”
While tax loss harvesting can be employed in any year, when there is a lot of volatility it presents a big opportunity for investors to unload their losses and reduce their tax exposure. Consider this: according to Sweeney between September and October 15, the stock market lost 8%, which means if you bought something over the summer chances are it was underwater in October. That would have presented you with an opportunity to sell the stock and book the losses to be used to offset gains from any outperforming stocks.
“What you are really trying to do is to offset some winners and losers,” says Sweeney. “You want to make sure you have opportunities throughout the year to look at your investments and take advantage when there are dips in the market.”
When it comes to tax loss harvesting there are rules investors have to follow in order to reduce the taxes they’ll owe Uncle Sam. For one thing, if you sell a losing stock to offset gains you have to wait 31 days before you can buy it back. That doesn’t stop you from purchasing a similar stock in that industry. What’s more you can only offset gains from stocks you held for the long term, which means you have to own them for at least twelve months. The strategy isn’t only for stocks. Manuel Andrade, senior vice president of People’s United Wealth Management says you can do it with mutual funds, bonds and even ETFs.
The size of your portfolio also doesn’t matter. Investors with a lot of money in the markets will hopefully have a large amount they need to offset but even people facing a capital gains tax of $5,000 can take advantage of this strategy, says Andrade. In fact the savings will mean much more to people who aren’t sitting on a huge portfolio.
Let’s say you are in the 15% tax bracket and you have a capital gain of $5,000. That means you’ll owe $750 in taxes at the end of the year. If you offset that with $5,000 in losses you won’t have to pay that $750, says Andrade. The one area where you can’t apply this strategy is with stocks and investments in your 401 (K). That’s because if you haven’t retired then you haven’t realized the gains in your portfolio yet and therefore don’t have to worry about the tax implications.
Tax loss harvesting doesn’t apply to everyone, even if they have capital gains during the year. That’s because if a married couple’s income is below $73,800 or $36,900 for individuals then you don’t have to pay taxes on any capital gains. So if your income is $60,000 and you have a capital gain of $10,000 you won’t have to worry about owing any taxes. But if you made $74,000 then you’ll want to see if there are any losses to offset the gains, says Dean Hedeker, owner of Hedeker Wealth Management. “It’s missed by a lot of people,” says Hedeker. “You can have someone with a $1 million portfolio and their income is less than $73,000.”