The Silver-Lining to Market Declines: Tax-Loss Harvesting

Even if you plan to hold investments for the long term, realizing some investment losses before the end of the year may reduce your tax bills for 2023 and beyond. Your brokerage account may have an assortment of mutual funds, ETFs, and stocks, some of which you've held for a long time. Next year, when you decide to finally hire a financial advisor, he or she might ask if you have any tax-loss carryforwards. If you have carryforward losses, they appear on Schedule D of your tax return. That means you harvested losses sometime in the past, so you can use those losses to offset future gains. For many investors, 2022 is an excellent year to take advantage of the opportunity for tax-loss harvesting before the calendar year ends.

Isn't It Better To Sell High?
Don't we want to sell high and buy low? You might ask.

In an ideal world, we wouldn't have to worry about taxes. Instead, we sell some investments at a loss, but at the same time, we use the proceeds to buy low. Then, when those new investments grow over time, we can sell them for a gain (high) and use the previous losses to cancel out the capital gains taxes that year.

But what if the market recovers? Shouldn't we wait until it recovers? You might be thinking.

You can still participate in the recovery. However, you must wait 31 days to repurchase it or risk violating the wash sale rules.

Beware Of Wash Sale Rules
One hazard of tax-loss harvesting is that you can't sell an investment and repurchase it within 30 days. If you do, the repurchase washes away the loss and won't count for tax purposes.

Instead, buy something similar. If you are in a Large Cap US Equity Mutual Fund and want to maintain your level of diversification, purchase another another Large Cap US Equity Fund that is not substantial identical to the fund sold from a different management company. If you like the investment management company, you could buy a different fund that tracks another index. Likewise, if you own individual stocks and sell a tech company stock for a loss, you can buy a similar tech company without violating the wash sale rules.

How Tax-Loss Harvesting Works
Let's say you harvest $30,000 in long-term losses this year but do not harvest any gains. You can use up to $3,000 of those losses to offset ordinary taxable income. You now have $27,000 in carryforward losses to offset income and gains in future years.

Continuing the example above, let's say you are married, file a joint tax return, and in the 24% tax bracket for federal income tax, and 20% rate for long-term capital gains tax. In 2022, your potential tax savings is $720 ($3,000 * 24%). Then, in 2023, you sell an investment for a long-term capital gain of $24,000, so you could save $4,800 ($24,000*20%) in tax liability and use the remaining losses to offset another $3,000 in ordinary income, saving another $720. So this tax-loss harvest strategy in 2022 saves you $6,240 over two years.

Remember that this strategy only applies to taxable brokerage accounts, not retirement accounts. You cannot deduct the losses generated in a tax-deferred account such as an IRA or 401(k).

Pulling Off The Bandaid
While we cannot control the markets, taking advantage of tax losses is within your control. If you need help pulling off the bandaid to harvest your losses, it might be time to work with an advisor. Financial advisors don't have an emotional attachment to your investments. When working with a fiduciary advisor, you can trust them to make tax-loss decisions in your best interest. For two decades, the fiduciaries at Hurlow Wealth Management Group have helped offset millions of dollars in taxes for their clients. Schedule an introductory call today!

Services offered through Hurlow Wealth Management Group, Inc., a Registered Investment Adviser. Hurlow Wealth Management Group, Inc. does not provide tax, legal or accounting advice. Advisory services are only offered to clients or prospective clients where Hurlow Wealth Management Group, Inc. and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Hurlow Wealth Management Group, Inc. unless a client service agreement is in place.