Tax-loss harvesting is a strategy used by many investors and their advisers as a way to reduce the amount of taxes owed. Despite tax-loss harvesting being a well-established tool, it remains controversial in some respects. For example, research continues and debate is ongoing as to the amount of value tax-loss harvesting adds to investors’ returns and tax-reduction efforts over time. One reason is that there are multiple ways to implement tax-loss harvesting, some of which may be more beneficial than others.
Smart Business spoke with Bob Bove, Wealth Advisor & Certified Exit Planning Advisor at The 4:8 Group, about tax-loss harvesting and what investors need to know to leverage the strategy for maximum benefit.
What is investors’ view of tax-loss harvesting?
Mitigating taxes is a major goal of many affluent investors, and long has been. In conversations with financial advisers, for example, CEG Worldwide consistently finds tax mitigation to be among high-net worth investors’ top five financial concerns. Likewise, about two-thirds of people (67 percent) consider their federal income tax to be too high, according to a 2024 University of Chicago Harris/AP-NORC nationwide poll of 1,024 adults.
The effectiveness of tax-loss harvesting will depend on many factors such as each investor’s circumstances and when the harvesting occurs. And while there are no guarantees, one study by academics at MIT and Chapman University suggested that tax-loss harvesting might boost a large-cap stock portfolio’s returns by as much as 1.1 percent per year.
How should tax-loss harvesting be implemented?
As with any investment strategy, tax-loss harvesting should be used in ways that reflect each investor’s situation and needs in order to generate the optimal benefits. And there are some key issues and risks to think through before seeking to harvest investment losses. For instance, after selling an investment at a loss in hopes of offsetting taxable gains, an investor’s next move is an important one. If they want to continue to have exposure to the type of asset they just sold, the obvious move would be to buy a similar investment — for example, replacing an S&P 500 ETF with another ETF that tracks that same index. But this is where an investor comes face-to-face with what’s called the wash sale rule, which says that if an investor sells a security at a loss and buys the same or a similar security within 30 days before or after the sale, they can’t claim the loss on their tax return. What’s more, the wash sale extends to other accounts, too. So, if an investor sells a stock in their taxable account then buys the same stock right away in their retirement account, they still violate the wash sale rule. However, they may be able to replace the sold security with one that is different enough to satisfy the IRS.
While the thought of using tax losses to reduce a tax bill might sound wonderful, it’s entirely possible to let tax-loss harvesting get out of hand and end up diluting its potential benefits. That’s in part because transactions such as selling securities, buying replacements and possibly even re-buying the initial securities likely come with costs. Getting overzealous with buying and selling can potentially erode a chunk of tax savings an investor might generate.
What steps should investors take to get started with tax-loss harvesting?
Tax-loss harvesting is a tool that most investors with taxable investment accounts should at least look into. That said, tax-loss harvesting should be just one possible move to consider when looking to mitigate taxes. Other strategies include converting a traditional IRA or 401(k) to a Roth IRA, taking advantage of tax-exempt or tax-managed investments, and implementing a charitable giving strategy with tax benefits.
Don’t treat tax-loss harvesting like it’s a magic bullet. Investors should examine and weigh their tax mitigation options, consult with a trusted adviser about the benefits and risks, and see whether tax-loss harvesting may fit into an investor’s comprehensive plan for keeping more of what they make. ●
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