In the midst of market fluctuations, investors are understandably on the hunt for ways to shield their portfolios. However, financial experts suggest that many might be overlooking an excellent tax planning strategy. This tactic is called tax-loss harvesting, which involves selling off investments that have lost value from a brokerage account to balance out other profitable gains, thereby reducing taxable income. Typically, these losses are used to counteract capital gains from selling investments or from distributions made by mutual funds or exchange-traded funds. If losses surpass gains, you have the option to deduct up to $3,000 from your ordinary income each year. Any remaining losses can be carried forward indefinitely to future tax years.
“It’s about finding a silver lining on a rainy day,” explains Sean Lovison, a certified financial planner and the founder of Purpose Built Financial Services in the Philadelphia area.
When market volatility is in play, considering tax-loss harvesting is worthwhile, according to experts. “This should be a year-round consideration,” says Lovison, who also holds a certified public accountant designation.
With the S&P 500 Index hovering more than 15% below its February high as of midday Tuesday, and having briefly dipped into bear market territory amidst trade uncertainty, tax-loss harvesting could be quite appealing. Here’s what financial advisors suggest you need to know about this strategy.
While tax-loss harvesting might seem straightforward, today’s market conditions demand a meticulous approach, says Judy Brown, a CFP at SC&H Group, operating in the D.C. and Baltimore regions. After years of market growth, newer investments might be where losses are likely to be found, notes Brown, who is also a CPA. She emphasizes the importance of carefully tracking “tax lots”—records that detail an asset’s purchase date and price.
According to Brown, having the right tools to quickly identify these lots is essential to seize the tax-loss harvesting advantage.
A vital component of this strategy is understanding the “wash sale” rule. This regulation can disqualify your tax deduction if you repurchase a “substantially identical” investment within a 30-day period around the sale. While the rule is relatively clear for individual stocks, the IRS provides less clarity on its application to mutual funds and ETFs, experts observe. For instance, exchanging one large-cap mutual fund for another from a different provider, assuming there are slight differences in holdings, is often permissible. However, if you’re buying back the same exact index composed of identical funds, that might not make it past the IRS’s scrutiny, warns Lovison.
