Will you Tax-Loss Harvest in your investment portfolio in 2024? (Here's how!)

This week, we’re going to look at a tax strategy that market declines make MORE attractive. 

Every year, during tax time, your CPA will have to report any capital gains or capital losses that you’ve realized across all of your taxable investment portfolios during the prior year (this is done via a 1099R Tax Statement).

A capital event (gain or loss) occurs any time you’ve sold any of the holdings inside your portfolio during the year (for mutual funds, there’s an extra level of nuance but the principle remains the same).

The tax ramifications for these gains and losses depend on how long you’ve held the positions at hand. If you held the security for over 1 year, it will be treated as a long-term gain or loss and, assuming you have gains, you will be taxed at a more preferential rate (15 or 20% for most of our clients) on those gains relative to the taxes you pay on earned income (W2 or self-employment income) throughout the year (which comes in at 32% or 37% for most of our clients.)

Alternatively, If you’ve held the security (stock, etf, index fund etc.) for less than a year, then the capital gain will be treated as a short term gain which has the same tax treatment as ordinary income as described above.

So, for example, if you have a taxable long term capital gain of $5k from your stock sales in portfolio A and $3k of capital losses from stock sales in portfolio B, when looked at together, you will have a total capital gain of $2k of long term gains…this $2k will be reportable on your tax return, and assuming a 20% long term capital gain rate, you will owe $400.

An important distinction to make is that all of this only applies to “realized” capital gains and losses. If you bought 10 shares of Amazon stock in 2012 and never sold a share, well, you’ve never actually “realized” any capital gains and so all those gains inside the portfolio have not been taxed yet. You haven’t yet materially profited from those shares. You will ultimately pay the tax gains on the increase in Amazon’s value when you start selling those shares.

Ok, so let’s look at situations when you actually have a capital LOSS on your books. When you have net realized capital losses (you’ve lost money “in the market” when you look at all of your portfolios together) those losses will actually go towards lowering your ordinary income tax liability for that year…. up to $3k annually and the rest gets pushed into future tax years.

Example: In 2024, you have $5k of capital gains in your accounts and $9k of capital losses. This means you have net losses of $4k. You can use $3k of those losses to offset ordinary income tax in the current year (amazing!) and the remaining $1k can offset capital gains in the following year.

Ok, realized capital losses can be a positive thing! That’s where proactive tax loss harvesting come into play.

In our managed accounts, we are always looking for opportunities to harvest losses where we can. When the markets are getting crushed as they have been, and losses materialize all around us, we are provided fertile ground to begin tax loss harvesting!

To do so, we will sell positions that are operating at a loss and buy a “secondary” holding (a similar holding that takes the same general position we just sold). We will hold this “secondary” holding for 31 days to avoid the wash sale rule, and then buy back the original holding that we originally built the portfolio strategy around. Every step of this multi-faceted approach is important. The benefits are compounded:

1. We harvesting the loss (by selling the position) and allowing you to use the fact that the market is losing money anyway to lower your tax liability & effective tax rate in the current year….Again, lemonade from lemons.
2. Because we are buying a “secondary” fund, we are not just sitting on the sidelines (sitting in cash) for the 31 days that we are waiting to buy back your portfolio. So if the market rebounds over that 31 day time period, we remain fully invested and will still be materially participating in the positive returns that the market begins providing.

To be clear, tax loss harvesting has to be done in an efficient, managed approach that avoids wash sale rules, aggregation rules between accounts and with an awareness of your tax bracket…It should only be done with a CFP® or Tax Advisor at hand…. but if you are not at least exploring how tax low harvesting during down markets can affect your overall tax planning you are ABSOLUTELY missing out.

Questions? We’re always here to speak!

As always you can schedule a 15 minute "Right Fit" call here so we can figure out together if there's more you can be doing now in your financial world. 🤙

-Gideon & The Drucker Wealth Team