A Little Good News in the Pain: Tax Loss Harvesting

While a time period like the first 4 months of 2022 when account values are shrinking is certainly painful to watch - I wanted to share one of the top value added services that we perform at Roloff Retirement Solutions, Inc: Tax Loss Harvesting.

It is important to note that when we do experience losses, we are still actively managing your portfolio.  What this does not mean is that we just sell everything in an attempt to avoid losses - more often than not, the bottom of the downturn cannot be predicted and the recovery starts well before the news or data makes it obvious that it's going to happen.  I've shared some other articles on the recent losses and certainly feel that there is reason for optimism going forward for all three major asset classes that we use - stocks, bonds and real estate.  What we may do during volatility is rebalance portfolios or reallocate to a more attractive area of the market (in our view).  Sometimes though, we may still feel good about all of our holdings and not make any material changes to our allocations.  However, for investors with taxable accounts (non tax sheltered accounts), we can perform "tax loss harvesting," a simple but financially beneficial adjustment to portfolios.  

What is Tax Loss Harvesting?

Quite simply - tax loss harvesting is selling an investment that is below its purchase price or tax base to generate a realized capital loss.  Many firms will look at these opportunities near year-end - but as an investment professional with tax expertise as well - I continually monitor for opportunities.  In some circumstances like during the COVID panic in spring of 2020, we will realize losses and make portfolio adjustments at the same time.  Other times - like in recent weeks, we may realize losses but keep our overall allocation the same.  For most investors in stock funds - there are rarely opportunities to realize losses after a period of time as you may have substantial gains so you're reducing gains, but not falling into an actual loss from your initial investment.  This year has been unique as there have been sizable losses in bond funds - even for investors that have owned funds for many years (because most of the profits from bond funds come from interest - NOT share price appreciation).  We have reviewed all of our client accounts and have made "tax loss swaps" in the large majority of accounts - selling current funds to realize losses and buying similar (but not the same) funds to maintain the same general investment position.  We do this so that we still stay invested in what we feel are good investment categories, while getting a tax benefit from the (hopefully) temporary losses.  

What is the Tax Benefit?

When you realize a capital loss on an investment, you can use this loss to offset other capital gains.  These gains could come from other investments sold at a gain - stocks, bonds, mutual funds, ETF's, Reits, even physical investment real estate.  You may also have capital gain distributions from mutual funds - gains that are passed through to investors from mutual funds - even though you didn't sell your shares.  We generally minimize use of mutual funds in taxable accounts for this reason (choosing instead to use more tax-efficient ETF's) - but there are some exceptions, as well as older mutual funds that we choose not to sell because they have substantial unrealized gains (these could be funds we bought years ago, or funds that an investor owned prior to working with us).  If there are still realized losses leftover after offsetting all capital gains - up to $3000/year may be used to offset other ORDINARY income - your wages, IRA distributions, pensions, etc.  This is the ideal situation as for all income levels - the tax rate on ordinary income is higher than the tax rate on long-term capital gains.  So if we can takes losses and reduce taxable income at ordinary income tax rates, even if we later have to sell the new investments and realize gains - it is likely to be taxed at a lower rate.  (barring future tax law changes or being in a higher tax bracket in the future)