Leveraging Tax-Loss Harvesting
November is a good time to review your portfolio as we head into the final days of 2024. You will want to look at your portfolio’s asset allocation as well as evaluating the holdings in your portfolio.
This is a good time to look for holdings with unrealized losses in your taxable accounts. While rebalancing your portfolio, or in your review of your holdings as you look to head into the new year, harvesting tax-losses can help reduce your overall taxes for the year.
How Does Tax-Loss Harvesting Work?
Tax-loss harvesting involves selling holdings with unrealized losses in your taxable investment accounts and using the losses to offset capital gains or other income for the year.
Capital losses are first matched with capital gains of the same type.
Any remaining gain and losses of both types are then matched up. To the extent there are excess losses, up to $3,000 of those losses can be used to offset other income you may have. Any remaining losses can be carried forward to be used in a subsequent tax year.1
Tax-loss harvesting is a tax-efficient way to reduce or eliminate holdings from your taxable accounts and can also be very useful in rebalancing your portfolio. Note that while many advisors and investors focus on tax-loss harvesting at year-end, it is a great tool to use all year round.
Beware of the Wash-Sale Rule
The wash-sale rule says that investors cannot purchase an identical or a substantially equal security within a 61-day period of having sold a holding for a loss. This period includes the date of the sale, the 30 days prior and the 30 days afterwards. Violating the wash-sale rule will negate your ability to deduct the loss.2
Identical securities are relatively straightforward. If you sell XYZ stock for a loss you cannot purchase shares of XYZ stock within this 61-day period. This not only pertains to the account in which the sale transaction took place, but in all of your accounts, including other taxable accounts, IRAs, retirement accounts such as a 401(k) and all other accounts that you might own.
Sometimes, the wash-sale rule can be violated unintentionally. Let’s say that you sold a portion of a mutual fund holding at a loss, but you still retain some shares. If during the wash sale rule, you receive a distribution from the fund and that distribution is reinvested, this would violate the rule.
In looking to replace shares of a security that was sold at a loss, make sure the replacement holding is different enough from the holding that was sold at a loss. For example, if you sold a mutual fund in the large cap growth category, there are any number of other funds in that category that are likely substantially different from the fund you sold. Even if the fund you sold was an index fund, you should be able to replace it with another fund tracking a different index in the same fund category.
Combining Tax-Loss Harvesting with Portfolio Rebalancing
Tax-loss harvesting is an excellent tool to use with portfolio rebalancing all during the year, not just at year-end. Selling underperforming assets offers a chance to invest in other areas while maintaining your desired asset allocation and maximizing tax efficiency.
Financial advisors generally recommend looking at your asset allocation throughout the year at regular intervals. This might be quarterly or semi-annually. While rebalancing your portfolio to get it back in line with your target asset allocation, you will need to sell a portion or the entire position in some holdings.
In some cases, within your taxable account(s), this will result in a realized capital gain. In others it will result in a capital loss. Where possible, it is a good idea to look at the tax consequences of selling a holding while rebalancing, but this should not be the deciding factor in determining whether or not to sell the holding.
When deciding which holdings to sell in your taxable accounts, always look for positions with an unrealized loss. Next, look at whether you feel the holding has solid upside potential, or if it makes sense to sell some or all of the position. If so, then it probably makes sense to sell those shares. To the extent this can be incorporated into your periodic rebalancing efforts, so much the better in terms of the overall tax impact.
To learn more about tax-loss harvesting and how this can be a beneficial strategy contact your Wedbush advisor.
1: IRS
2: IRS
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