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Creating a well-diversified portfolio is the foundation of growing wealth. But there's an aspect that may help increase your overall return – and it isn't just an investment strategy. Being strategic about handling asset value declines is also a tax strategy. It can help you offset capital gains taxes resulting from managing your portfolio or taking income in retirement.
There's also a provision in the tax code that allows you to offset a portion of ordinary income if the loss is greater than the capital gains taxes you are liable for. And you can carry it forward indefinitely.
Being proactive and thoughtful about managing the “losers” in your portfolio should be part of your overall strategy, whether or not it makes sense to sell a position and turn a paper loss into a tax offset. Making the decision involves looking across your financial picture and investment strategy, and there are some pitfalls to avoid.
Rebalancing your portfolio to ensure that it reflects your desired investment strategy and risk tolerance is an essential part of portfolio management. Trimming back a position that has gained substantially may be necessary if it is creating more risk in your portfolio than you are comfortable with.
The sales would result in capital gains taxes, either short-term if the position was held less than a year or long-term if the asset has been in your portfolio for a year or more. Long-term capital gains taxes are much lower than the tax on short-term capital gains.
The IRS allows you to offset capital gains with a capital loss. In a situation where you don't have gains to offset, you can use up to $3,000 of losses to offset ordinary income. That doesn't mean you have to keep a declining position in your portfolio – you can carry the loss forward until it is all offset.
Your investment strategy is the most critical aspect, so start with investments that meet any of these criteria:
• Doesn't fit your existing investment strategy, or you want to change
• Growth prospects have dimmed
• The position can be easily replaced with something else with similar utility in your portfolio
Next up are tax considerations. The IRS has created a hierarchy for how losses can be used to offset gains. First, they have to be used against the same type of gains. So, short-term losses offset short-term gains, and long-term losses offset long-term gains.
If your short-term losses are greater than your short-term gain, the excess can be applied to long-term gains and vice-versa.
Finally, if you are selling a position that you acquired over time at different costs, look at the cost basis and maximize your tax benefits by selling the highest-cost-basis shares.
You want to maintain your portfolio diversification, so unless your strategy has changed drastically, you may want to purchase a similar asset. This can get tricky. The IRS has created a rule to prevent simply switching out of a loss for the tax benefit and then repurchasing the asset at a lower cost.
It's called the "wash-sale rule" and states that your write-off will be disallowed if you purchase the same or a substantially identical security within a 30-day window either before or after you sell to harvest a loss.
This is usually efficiently manageable – but if you have an Employee Stock Purchase Plan with a specified purchase date, or you hold company stock that has a vesting date, you'll need to be extra careful and aware of your dates.
If the position you sell represents an industry sector exposure, you can generally replace it with a mutual fund or ETF without creating a wash sale. Just be aware of the costs of the transaction.
Tax-loss harvesting can be a useful portfolio management tool that can lower your tax costs. It can be part of an annual rebalance, or you may keep the tax benefits in mind as you opportunistically invest throughout the year. Your investment strategy should always be the priority, and to get the maximum benefit, think through the implications of the sales of both gains and losses before you execute. And of course – consulting your financial and tax advisor is always a good idea.
Creating a well-diversified portfolio is the foundation of growing wealth. But there's an aspect that may help increase your overall return – and it isn't just an investment strategy. Being strategic about handling asset value declines is also a tax strategy. It can help you offset capital gains taxes resulting from managing your portfolio or taking income in retirement.
There's also a provision in the tax code that allows you to offset a portion of ordinary income if the loss is greater than the capital gains taxes you are liable for. And you can carry it forward indefinitely.
Being proactive and thoughtful about managing the “losers” in your portfolio should be part of your overall strategy, whether or not it makes sense to sell a position and turn a paper loss into a tax offset. Making the decision involves looking across your financial picture and investment strategy, and there are some pitfalls to avoid.
Rebalancing your portfolio to ensure that it reflects your desired investment strategy and risk tolerance is an essential part of portfolio management. Trimming back a position that has gained substantially may be necessary if it is creating more risk in your portfolio than you are comfortable with.
The sales would result in capital gains taxes, either short-term if the position was held less than a year or long-term if the asset has been in your portfolio for a year or more. Long-term capital gains taxes are much lower than the tax on short-term capital gains.
The IRS allows you to offset capital gains with a capital loss. In a situation where you don't have gains to offset, you can use up to $3,000 of losses to offset ordinary income. That doesn't mean you have to keep a declining position in your portfolio – you can carry the loss forward until it is all offset.
Your investment strategy is the most critical aspect, so start with investments that meet any of these criteria:
• Doesn't fit your existing investment strategy, or you want to change
• Growth prospects have dimmed
• The position can be easily replaced with something else with similar utility in your portfolio
Next up are tax considerations. The IRS has created a hierarchy for how losses can be used to offset gains. First, they have to be used against the same type of gains. So, short-term losses offset short-term gains, and long-term losses offset long-term gains.
If your short-term losses are greater than your short-term gain, the excess can be applied to long-term gains and vice-versa.
Finally, if you are selling a position that you acquired over time at different costs, look at the cost basis and maximize your tax benefits by selling the highest-cost-basis shares.
You want to maintain your portfolio diversification, so unless your strategy has changed drastically, you may want to purchase a similar asset. This can get tricky. The IRS has created a rule to prevent simply switching out of a loss for the tax benefit and then repurchasing the asset at a lower cost.
It's called the "wash-sale rule" and states that your write-off will be disallowed if you purchase the same or a substantially identical security within a 30-day window either before or after you sell to harvest a loss.
This is usually efficiently manageable – but if you have an Employee Stock Purchase Plan with a specified purchase date, or you hold company stock that has a vesting date, you'll need to be extra careful and aware of your dates.
If the position you sell represents an industry sector exposure, you can generally replace it with a mutual fund or ETF without creating a wash sale. Just be aware of the costs of the transaction.
Tax-loss harvesting can be a useful portfolio management tool that can lower your tax costs. It can be part of an annual rebalance, or you may keep the tax benefits in mind as you opportunistically invest throughout the year. Your investment strategy should always be the priority, and to get the maximum benefit, think through the implications of the sales of both gains and losses before you execute. And of course – consulting your financial and tax advisor is always a good idea.
The subject matter in this communication is educational only and provided with the understanding that Sanctuary Wealth is not rendering legal, accounting, investment advice or tax advice. You should consult with appropriate counsel, financial professionals, or other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.
Registered Representative of Sanctuary Securities Inc. and Investment Advisor Representative of Sanctuary Advisors, LLC. Securities offered through Sanctuary Securities, Inc., Member FINRA, SIPC. Advisory services offered through Sanctuary Advisors, LLC., an SEC Registered Investment Advisor. Credo Wealth Management is a DBA of Sanctuary Securities, Inc. and Sanctuary Advisors, LLC. This work is powered by Advisor I/O under the Terms of Service and may be a derivative of the original. This communication has not been reviewed for completeness or accuracy, does not necessarily reflect the views of Sanctuary Securities, Inc. or Sanctuary Advisors, LLC., and is not a recommendation or endorsement of any product, service, or issuer. For additional information, please refer to one of the following consumer websites: www.FINRA.org, www.SIPC.org.
We’ve worked with many of the largest corporations in the Bay Area. We know the ins and outs of their programs and we’re happy to give you an objective opinion.
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