Tax
What is tax loss harvesting?
What can investors do when asset value of investments decline?
If the value of an asset has declined, you may be able to harvest those losses to offset capital gains elsewhere.
We hear that some investors may be feeling torn apart with their investments between income distributions and declining asset value. Despite high distribution rates, some investments may have experienced significant net asset value (NAV) erosion, resulting in less favorable investment returns than original goals. While some covered call ETFs boast extremely high distribution rates on the surface, a deeper dive into its total returns reveals a much different story.
Investors should carefully look underneath the hood of high distribution rates and examine total return numbers to understand true value of their investments and performance. High distributions can sometimes mask underlying losses. If a security has faced substantial declines, it can be a potential opportunity for tax loss harvesting. By realizing losses in investments and reallocating into more stable alternatives, investors can better align their portfolios with their longer-term financial goals.
What is tax loss harvesting?
Harvesting losses means selling investments in taxable accounts that have lost value to offset capital gains elsewhere and help reduce taxes overall.
How does it work when you sell an investment that's underperforming and losing money?
You use that loss to reduce your taxable capital gains and potentially offset up to $3,000 of your ordinary income (or $1,500 each for married taxpayers filing separately). Any amount over $3,000 can be carried forward to future tax years to offset income in the future.
Then, you reinvest the money from the sale in a different security that meets your investment needs and asset-allocation strategy.
Why do investors tend to consider tax-loss harvesting at the end of the year?
There are three key reasons:
Offsetting gains: Investors often scramble to harvest losses in December to balance out gains realized earlier in the year and reduce their tax bill.
Common timing: It's become a standard end-of-year practice because financial advisors and media emphasize it as part of "tax-loss harvesting season."
Procrastination: Harvesting losses is time-consuming and reminds investors of poor decisions, leading many to delay it until year-end.
However, it's usually not good to wait until December to harvest tax losses because markets can be more volatile, and waiting too long may result in missed opportunities to offset gains, especially if market conditions change or potential losses recover before the year-end.
Issues to understand before utilizing tax-loss harvesting
Tax-loss harvesting doesn’t apply in retirement accounts, such as a 401(k) or an IRA, because you can't deduct the losses generated in a tax-deferred account.
There are restrictions on using specific types of losses to offset certain gains. A long-term loss would first be applied to a long-term gain, and a short-term loss would be applied to a short-term gain. If there are excess losses in one category, these can then be applied to gains of either type.
You should also be aware of the wash-sale rule, which states that if you sell a security at a loss and buy the same or a "substantially identical" security within 30 days before or after the sale, the loss is typically not allowed for current income tax purposes.
Talk with your tax professional or schedule a chat with Kurv's Client Solutions member if you would like to discuss solutions for your clients. Schedule a chat.