Many investors optimize their portfolio to minimize capital-gains tax.
One popular strategy is to do tax-loss harvesting.
What is tax-loss harvesting?
Tax-loss harvesting is the practice of selling a position at a loss, and matching the loss
against a gain of different stock that you sold.
By offsetting losses against gains, capital growth taxes are only paid on the net profits.
While this may be a tempting tax-savings strategy, there are three reasons to avoid the end-of-the-year
market selling frenzy.
The wash sale If you sell a security and buy it (or a substantially
similar one) back within 30 days of selling it is called a “wash sale.”
Wash sales negate any tax-loss selling strategies, and your attempt to harvest a tax-loss would
be disallowed by the IRS.
Don’t be the short-sighted individual who sells at a loss, and then, the next day when
the stock begins creeping up, wants a piece of the action and buys it again.
This scenario nullifies any potential benefit of tax-loss harvesting, and causes further
losses by increasing commission costs.
Impending tax law changes Selling a position at a loss allows you to
offset taxes on potential capital gains in a given tax year.
However, since the tax codes are constantly changing you can’t know what your future
tax situation will be.
If the government raises capital gains tax next year, you may have been better off saving
your tax-loss harvesting to use in a year with a higher capital gains tax.
Also, for American tax-payers, capital gains tax is different on long- and short-term investments,
so the time you originally purchased the security may affect its potential taxes.
Market uncertainty The uncertainty of knowing when a declining
position may reverse itself adds further ambiguity to tax-loss selling.
An unrealized loss might actually turn around.
But if you sell just to capture the loss, you can’t benefit from the recovery.
While tax considerations should come into play when making buy/sell decisions, tax considerations
should never be the only reason behind a transaction.
Always ask first If you are considering tax-loss harvesting,
consult both your tax and financial advisors.
You should always ask a tax professional before making any decisions that can affect your
taxes.
Call my office (02-624-2788) if you have any questions about your portfolio.