Harvesting tax losses is a brilliant wealth-creating technique. Selling your loss positions is a sure way to offset gains realized during the year and stockpile losses for future years. Capital losses in excess of capital gains can reduce other income by $3,000; any excess loss is carried forward for use in a future year. Remember that if you sell stock for less than you paid for it, the wash sale rules bar deducting a loss on a security when a virtually identical one is purchased within 30 days of the sale. Long-term investors can retain exposure to their chosen portfolio by purchasing a similar holding after selling the loss position.
When the stock market is volatile, it is a great time to harvest losses. In times when the stock market is rising, mutual funds often distribute large capital gains that would be offset by capital losses. If enough losses are harvested in your account during a market correction, you’ll see the benefit for many years to come in the form of lower annual tax bills.
Here’s an example of how this technique is used if there’s been a large capital gain such as from selling your company. In January 2008, a client invested the proceeds from the sale of his company into the stock market. Fate then took an interesting turn. The broad stock market started to plunge; it was the start of the Great Recession, and the market was melting. Between the summer of 2008 and the bear market low on March 9, 2009, we reviewed the client’s investment portfolio often to harvest and realize the losses from the market’s drop. Selling one position and buying a similar but not identical holding to retain market exposure is what we always do for clients during market downturns.
Although the proceeds from this client’s decade of hard work lost one-third of their value during those 15 months between when they were invested and the bear-market low, grabbing those tax losses turned out to be hugely helpful to the client’s 2008 and 2009 tax bill. During this time, we had successfully preserved—or realized—losses of an amount equal to approximately 30% of the cash he invested in January 2008. We essentially used these losses to offset the gain from the sale of his company.
The tax loss harvesting strategy works well for anyone with a taxable portfolio. For example, if there is a $200,000 unrealized loss in your portfolio, you can sell the securities, realize the loss, and buy a similar but not identical version of those securities to maintain your asset allocation. If you’re in the top tax bracket, you will have saved about $70,000 in taxes, to be used to offset capital gains dollar-for-dollar in the current year. For any losses not used in the current year, you can carry over the unused losses to a future year.