Sage Advice for Year-End Tax Harvesting, Wash Sales, and Charitable Gifts

The end of the year is an exciting time. When it comes to managing money and making smart year-end decisions there are a few topics that efficient asset managers know intimately. If you are advising individuals on year-end giving strategies, you better know about these topics as well. Let's walk through them one at a time and then analyze how they can work together.

Tax Harvesting is a time-tested and proven method for mitigating capital gains tax liability. It requires the selling of both winners and losers. The goal of the technique is to lock in gains but minimize the tax bite that comes with selling this year's big hits. Let's look at a simple example to illustrate the effect. Let's say "Bobby" owns only two stocks: Nvidia and TeleDoc Health. Year-To-Date these stocks are up 183% and down 60% respectively. Bobby might want to lock in some of the gains of his Nvidia stock, but because it is up so much, that capital gain tax bill is painful to consider. Conversely, TeleDoc Health has been hammered this year and selling at a big loss feels like admitting to a bad investment decision, he's hoping it will recover next year. Effective tax harvesting would consider selling off a portion of the Nvidia shares to lock in those wins AND selling off a chunk of the TeleDoc shares too offset the gains from the Nvidia sale. The realized capital loss is applied to the realized capital gain and only the net result flows through to his tax calculations.

Let's keep this story moving along and recall that Bobby thinks Teledoc isn't a lost cause and really believes in the future of telemedicine and virtual healthcare delivery so he repurchases shares a week after selling them... Very Bad News- This triggers the Wash Sale Rule and eliminates his ability to take that capital loss from the sale, and triggers full taxation of his capital gain from his sale of Nvidia. The Wash Sale Rule was enacted to prevent abuse of the rule that allows you to reduce your taxable income due to realized capital losses. A Wash Sale actually has a window of 60 days, 30 days before or after selling the investment at a loss.

If Bobby is trying to do some year-end tax harvesting, he should wait until at least 31 days after the sale to repurchase the same (or "substantially similar") stock investment. Bobby could repurchase the Nvidia stock though if he felt like it still has room to grow since wash sales only apply to investments sold at a loss.

What about those year-end charitable gifts then? How does that fit in? Let's say in addition to doing some tax harvesting, Bobby wants to support his charitable interests. Bobby could write a bunch of checks, but is that the most effective way? (The answer is No) Let's continue the storyline above- Bobby wants to mitigate the capital gain on his Nvidia investments and is hoping that Teledoc will recover next year. Bobby could donate shares of Nvidia directly to charity, avoid 100% of the capital gain, earn a charitable tax deduction of 100% of the market value of the shares donated, and, if he still wants to own the stock, he can repurchase it immediately without concern of losing his tax-harvesting intentions. An ancillary benefit of this strategy is that he will increase the cost basis of his Nvidia holdings, actually reducing future capital gain tax liability.

Being an effective philanthropic advisor requires more. Evolving from a solicitor of gifts to a trusted advisor requires us to provide more value to our donors. Year-end is when donors are most likely to have these questions and opportunities. Are you prepared to be the sage voice of wisdom? Or are you just asking people to make a year-end gift?