It's Harvest Time: How to Use Tax-Loss Harvesting to Reduce Your Taxable Income

You might be looking out your window at the slush and snow and thinking "what is he talking about?" You'd be right to wonder, if "harvest time" brings to mind rolling fields and tractors.  However, I'm not talking about amber waves of grain, but rather saving you some green, through tax-loss harvesting. Tax-loss harvesting may be an opportunity to reduce your taxable income, softening the blow of a down market.

The long and short of it

In short, a tax-loss harvest occurs when we sell poorly performing positions in taxable accounts and use the losses to offset taxes on any capital gains.  In addition, up to $3,000 of losses, in excess of investment profits, can be deducted against ordinary income, increasing your portfolio's tax efficiency.  This is another reason that having a balanced and diversified portfolio is beneficial, as it increases the potential for tax-loss harvesting.

For example, if you make an investment of $100,000 in a taxable asset, and it falls to $90,000, you could sell it and "harvest" the $10,000 loss by claiming it against other taxable gains.  In some cases, you may be able to claim the loss against up to $3,000 of ordinary income.  Suppose you have gains of $5,000 from another asset, those gains would be offset by $5,000 of your $10,000 loss.  You can then use $3,000 of your loss to reduce your ordinary income.  The remaining $2,000 may be carried forward to the next tax year.  Of course, as with anything involving tax law, it isn't always that straightforward.

It's a wash

I'm sure you've heard the colloquialism "it's a wash;" it definitely applies to loss harvesting, in the form of the "wash sale rule."  The wash sale rule is the Internal Revenue Service's way of dissuading you from selling assets for the sake of the tax write-off, so there are several things to keep in mind to make sure you're not violating this rule and negating your potential tax benefits.

• You cannot, within 30 days before or after the sale, make a "substantially identical" asset purchase. This will prevent you from claiming the loss on your taxes.
• The rule applies to multiple accounts held by a taxpayer, as well as his or her spouse, including IRA's and Roth IRA's.

Not for everyone

However, there are some instances that may make tax-loss harvesting less than ideal.

• It may not benefit clients who are eligible for the 0% capital gains tax rates.
• Realizing tax losses lowers tax basis, which makes harvesting harder to do the longer the portfolio grows and may potentially present other tax planning challenges in the future, especially if you are in a higher tax bracket.

Like so many investment strategies, tax-loss harvesting might not be the perfect strategy for every investor, but its potential benefits warrant a discussion with your Certified Financial Planning professional.  If not this year, maybe next—like a farmer planning a crop rotation during the winter months, there's never a bad time to think about your asset allocation and start planning ahead.  The market, like the weather, can be unpredictable, but as a personal financial advisor, I always like to be thinking ahead and looking for innovative ways to put my clients' wealth to work for them.  It may be the first quarter now, but the fourth quarter, like harvest time, will be on the horizon before you know it.

About Jim Cantrell and Financial Strategies, Inc.
Jim Cantrell, Certified Financial Planner Professional, is Owner and Founder of Financial Strategies, Inc. (FSI), Brookfield, WI (phone: 262-821-1664, email: [email protected]).  FSI is a Fee-Only wealth advisory firm.  Jim is also a National Association of Personal Financial Advisors (NAPFA) Registered Financial Advisor and NAPFA Board Member.  He has over 25 years of experience in financial planning and investment advising to top-level executives and other investment savvy individuals and retirees, as well as their families.  Jim has been named one of the country's top wealth managers by several leading publications.

FSI's Fee-Only structure ensures that clients receive honest and objective advice that is not dependent upon a commission structure for the financial success of the advisor.  Known by clients for their dedication, attentiveness and teamwork, the staff at FSI combines creativity, kindness and professionalism to give the best possible care and service.  For more information on Financial Strategies, Inc, please visit, www.retirementandwealth.com.

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SOURCE Jim Cantrell and Financial Strategies, Inc.

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