By Eric Estelle, Manager, Financial Planning & Marketing
In general, the stock market has been on the rise in 2021. However, not all investments rise and fall in lockstep. It is possible to have several positions in your portfolio with significant gains and others with comparable losses. These disparities could mean your portfolio needs a re-balance, but this potential problem might also provide tax savings opportunities. You might be able to mitigate capital gains taxes and reallocate your portfolio in a tax efficient manner by using a strategy called “tax loss harvesting.”
For tax purposes, all short-term gains and losses are first netted against each other. Similarly, long-term gains and losses are netted against each other. Then, these two figures are combined to determine the overall net short-term or net long-term gain or loss. To the extent that losses offset gains, you avoid the capital gains tax. If you have more losses than gains, you can offset ordinary income by as much as $3,000 on your federal tax return. Any remaining losses may be carried forward to the next year.
Once you sell a security you will need to evaluate how to invest the proceeds and it’s important to be aware of the “wash-sale” rules. These stipulations restrict you from purchasing the same or substantially identical security within 30 days of the sale of the original investment and recognizing the loss – this includes the period 30 days prior to the sale, and 30 days after the sale. Therefore, if you’d like to purchase the same security while avoiding violation of the wash sale rule, you can wait 31 days and then repurchase the same security. To repurchase the same security within the 2021 tax year, the sale would need to take place on or before November 30 and repurchase on December 31. Wash-sale rules do not apply to realized gains, only realized losses. You can sell an appreciated investment and buy it back immediately. Assuming you have enough losses to offset the gain, this would allow you to reset your cost basis (which is now equal to the price per share at the time of re-purchase), continue to hold an attractive investment, and avoid the capital gains tax.
A few other takeaways to consider when evaluating tax loss harvesting:
- Before making any changes, it’s important to make sure your portfolio is aligned with your goals.
- Trade date is used when determining your holding period, not the settlement date.
- Managing taxes can be complicated, so it’s important to consult with your tax professional for guidance tailored to your specific situation. Please remember, Benjamin F. Edwards does not provide tax advice.
- While year end is typically when people consider this strategy, it’s something to evaluate throughout the year.
Investors should also be aware of the potential for capital gains distributions from mutual funds, even if they don’t sell them. The long-running bull market has resulted in strong mutual fund capital gains in recent years and many sectors of the market are higher again in 2021.
If you need help evaluating your capital gains and losses for the year, contact a financial advisor for assistance.
Benjamin F. Edwards & Co. does not provide legal or tax advice, therefore it is also important to consult with your legal and tax professionals for additional guidance tailored to your specific situation.