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In a balanced portfolio, there’s always a chance of some investments underperforming. While backing losers isn’t ideal, there’s a way to ease the pain when it comes to year-end taxes.
Tax-loss harvesting is a strategy whereby portfolio losses can be offset against taxes on capital gains owed when you sell assets at a profit. If the losses exceed the profits, one can also offset taxes on other capital gains, like those from property or business sales.
Additionally, these losses can be employed to offset taxes on ordinary income — up to $3,000 a year in total can be offset this way — and losses not recovered in one year can be carried forward into subsequent years.
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The capital gains you pay on profitable trades depend on how long you’ve held the assets. For positions held for more than one year, the rates are either 0%, 15% or 20%, depending on your taxable income. If you’ve held the positions for less than a year, your profits will be taxed at your normal income rate.
That’s 37% at the federal rate — more in some higher-tax states such as New York and California.
The rules on tax-loss harvesting, however, don’t allow for investors to take a taxable loss in an asset and then repurchase the same position straight back.
To get around this so-called “wash-sale” rule, tax lawyers interviewed by Bloomberg suggest replacing the sold asset with something with a different risk profile.
For example, Bloomberg suggests that if you sold out of your position in the SPDR S&P Regional Banking ETF (NYSE:KRE), which is down 10.78% this year, you could buy the iShares US Regional Banks ETF (NYSE:IAT), which is down 12.68%.
So, as we come to the end of the year, investors should be busy assessing their portfolios to figure out how best they can use this strategy to offset their tax bills. It’s worth $3,000, so get those calculators out.
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