Market volatility can be uncomfortable, but it can also present opportunities. While it’s always a good idea to make sure your portfolio is aligned with your risk profile and target asset allocation (to make sure your portfolio is where it should be to participate in a rebound), another opportunity when markets fall is to harvest capital losses.
Tax-loss harvesting involves selling securities for less than what you initially paid for them in order to use the losses for your benefit. While this strategy doesn't get rid of your losses, it can help to manage your tax liability.
How It Works
Federal tax law allows for capital gains generated in the current year to be offset by capital losses. On its own, capturing losses to offset gains is a helpful strategy to minimize taxes associated with your investment portfolio.
Generating losses in excess of current year capital gains can amplify the tax savings: capital losses can offset up to $3,000 of ordinary income and any remaining losses can be carried forward to future years to reduce gains and/or ordinary income until used up. Therefore, depending on how much you have invested on an after-tax basis, a poor stretch in the markets could minimize or eliminate capital gain taxes for years to come - well after markets recover.
After selling the investment(s) at a loss, use the proceeds to purchase another investment in the same asset class (or deploy the proceeds elsewhere if your portfolio needs to be rebalanced) so you stay invested in the market. This last step in the process is crucial and distinguishes this tax-saving strategy from a market timing ploy.
Wash-Sale Rule
When implementing this loss harvesting strategy, be sure to watch out for the “wash-sale” rule. The IRS will disallow the loss if you buy the same or a “substantially identical” security within 30 days before or after the sale (even if the security is purchased in a different account or registration by you or your spouse). In other words, you can’t just sell a security to capture the loss and then quickly replace it.
Be sure to consult your tax professional if you have questions about the tax implications of implementing loss harvesting or how to adhere to federal and state rules.
Year-Round Strategy
While some investors only think about tax-loss harvesting as the year comes to a close, it’s a practice that should be on your radar year-round.
For self-directed investors, look for harvesting opportunities whenever you rebalance your portfolio, especially during periods of heightened volatility.
For our actively managed clients, we look for harvesting opportunities throughout the course of the year. And since we monitor portfolios on a daily basis, we’re able to act quickly when markets are volatile. The S&P 500 has nearly recovered all its losses since the announcement of widespread tariffs last month, but in the midst of the turbulence, we were harvesting losses where possible and rebalancing portfolios so they were properly positioned for the ensuing rebound.
We can’t control markets, but when it comes to our investments, we do have the ability to use inevitable volatility to our advantage to save on taxes while managing risk.
The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding investments, sectors or markets in general. The above statistics and/or commentary have been obtained from sources we believe are reliable, but we cannot guarantee their accuracy or completeness. Past performance is no guarantee of future results.
Specific securities discussed herein are illustrations and do not represent securities purchased, sold or recommended for client accounts. Such information does not constitute, and should not be construed as, a recommendation to buy or sell specific securities.
This is not a complete analysis of every material fact regarding any company, industry, or economic condition. Due to shifting market conditions, all expressions of opinion are subject to change without notice.
The information contained in this document does not constitute the rendering of legal, accounting, or other professional advice or opinions on specific facts or matters. Before implementing any ideas suggested here, consult with your tax advisor regarding your specific tax situation.
Talk to your financial advisor before acting on information in this document.