I am revisiting a topic I wrote about some time ago. Mostly because it is too important not to remind everyone of, but also because of a conversation I had recently, which is a whole other story. For now, let’s talk tax loss harvesting.
Alright, you know I focus quite a bit on tax planning. Call it Not Tipping Uncle Sam or It’s Not What You Make; It’s What You Keep. Heck, one of my clients refers to it as “Not feeding the beast.”
Regardless, tax planning is something more in control than thinking anyone can control the market. Plus, it has a huge impact on your overall success as an investor and in retirement. Fees too, but that is a whole other story.
Tax loss harvesting is something I do with my clients where I manage their assets. However, it is something you can do if you have the time to dedicate to it. Here’s the basic concept. And it is truly basic. If you want to get deeper, ask your CFP about this. I would say talk with your CPA but my experience is many CPAs aren’t aware of this technique.
Tax loss harvesting is simply selling an investment that has gone down in price from where you bought it. You take the losses and use them to reduce current taxes and/or future taxes. They can also be used to offset gains on those investments where you made a profit.
Something that holds back a lot of investors with tax loss harvesting is the whole wash-sale rule. Simply, this limits you from repurchasing an investment you just sold for at least 30 days. The example I use is you bought Apple at $100 a share and sold it for $60 a share. You have to wait more than a month to rebuy Apple otherwise you lose that $40 loss for tax purposes.
Here is where I most commonly use tax loss harvesting with my clients. It involves ETFs. ETFs enjoy what I can only describe as a nice loophole where you can sell an ETF, grab the losses, and immediately reinvest into a similar ETF. So, no waiting 30+ days to get back into this investment. You basically stay invested the whole time while grabbing the tax losses.
Simple example. You own a Vanguard Large Cap ETF and paid $100 for it. You sell it for $60 and grab the $40 loss for tax purposes. However, you do not want to sit in cash for the next month. You can immediately buy a Large Cap ETF from iShares. Although these two ETFs are very similar, they are not considered identical per the IRS.
If you want to do this on your own you can. The easiest way is to have two lists of ETFs. One from one company and the second list is from another. Say, one list of Vanguard ETFs and the other is all iShares ETFs.
Here is where it gets time consuming. Tax loss harvesting is a year-round sport. Most advisors focus on this only at the end of the year. To do this effectively you need to watch your accounts and individual investments EVERY SINGLE DAY. Personally, I bring in a team of outside investment experts to run the tax managed portfolios for my clients. Their job is solely to do this. And they do it well and at a low cost.
I expect this loophole to close at some point in the future. However, for now it is open and available for use. Again, it is more complicated than it seems and there are tax rules to be aware of when executing this strategy. There is no law prohibiting you from doing this on your own. You just need to spend your days from 9-4:30 EST watching your investments. Personally, I can imagine lots of better ways to spend my time.
Hopefully this is beneficial. Again, if you want to pursue this route I would talk with your CFP. This is in no way any specific type of recommendation for you start doing tax loss harvesting on your own. I simply wanted to share how I do it for my clients.
I’m Dan Johnson, CFP®, founder of Forward Thinking Wealth Management. I run a flat-fee financial planning and investment management firm located in beautiful Akron, OH. Although I am in Akron, OH, I work with clients regardless of location. I cater to owners of equity compensation positions who are looking to organize their financial lives, keep more of what they make, and do the things they want in retirement and even now.