I like to look for silver linings. For instance, during the pandemic lockdown, I appreciated the blessing of having family dinners with my wife and teenage daughters every night (and it was EVERY night!). It is important to make the best of even the bad situations. And this year has been a bad situation for most investment portfolios, so how do we make the best of it and find the silver living? One idea is tax loss harvesting.
To understand tax loss harvesting, you have to understand a little bit about how investments are taxed. Most retirement accounts are fully taxed when you take the money out of the account, so there’s not much you can do about this other than put that date off for as long as possible. Tax loss harvesting instead is focused on fully taxable, non-retirement investment accounts. These are accounts that typically generate a 1099 tax form each year showing the amount of dividends and capital gains that need to be included in your taxable income for that year.
There is generally nothing you can do to manage the taxes on your dividends within a taxable non-retirement account. Dividends are taxable in the year that they are paid out, regardless of whether these dividends are reinvested or not (this is a common misunderstanding with many investors). However, capital gains are only taxable when the underlying investment is sold so there is some ability to control when those gains (or losses) are recognized for tax purposes.
Bottom line – tax loss harvesting is the strategy of selling investments that are in a loss position so that those losses can offset taxable gains and reduce your tax liability in the year of sale. Just note that the proceeds from those sales cannot be immediately reinvested into the same investment. That would be considered a wash sale, and the tax benefits would be nullified. While this has been a bad year for many investments, it might be a good year to look at your non-retirement investment accounts for tax loss harvesting opportunities, or talk with your experienced financial advisor who can help you to take advantage of this silver lining.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
Neil Manning, CFP, AIF, CDFA, FSA
I am a reformed actuary turned financial advisor, helping my clients with everything from investments to retirement projections to LTC insurance since 2014. Unlike most normal people, I love numbers and finance – I’m currently reading a book about game theory which my wife and two teenage daughters think is unbelievably boring (they are wrong). For more details about my background, check out my website below.