Taxes are one of the biggest drains on your portfolio. At Soundmark, we are continuously looking for ways to minimize your taxes and maximize your gains. When the stock market is down, it creates a unique opportunity to harvest losses in taxable accounts.
Tax-loss harvesting involves selling a fund at a loss and immediately investing that money in a similar, but not identical, fund. This strategy allows you to realize a loss that can be used against capital gains (and capital gain distributions) while also allowing you to stay invested in a similar fund. In summary, your exposure in the stock market stays the same, with the added benefit of being able to recognize losses on your current or future tax returns.
Real-life scenario with tax-loss harvesting:
Let’s say you have a portfolio that creates approximately $10,000 in capital gain distributions (i.e., gains from the sale of stocks within mutual funds). Let’s also say you have $100,000 in a fund that has $20,000 in unrealized losses. By selling the $100,000 fund, you would realize a $20,000 loss.
We would then immediately invest the proceeds from that sale into a similar, but not “substantially identical,” position. That way, you maintain the same allocation you had before the sale.
Your $20,000 loss can then be used against your capital gains distributions for that tax year. At the current 15-percent tax rate for long-term capital gains, this move would save you approximately $1,500 in taxes. If you have no further capital gains for the year, you can also take an additional $3,000 loss at your ordinary income tax rate. Assuming a 25-percent tax bracket, you would get an additional tax savings of $750, for a combined total savings of $2,250 for the year ($1,500 + $750). Any unused losses, in this case $7,000, would be carried forward to the next year and used in the same manner as above.
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If you have questions about tax-loss harvesting or other tax strategies, please connect with Soundmark Wealth.