Tax Loss Harvesting

Have you ever opened a trade only for it to immediately decrease in value? Maybe you've started a long-term investment in the red and wished for a do-over? There is a technique the ultra-rich use to capitalize on their losses while still maintaining market presence. It's called tax loss harvesting, and although it's not as exciting as a position surging 2-3 times in value, it's better than enduring a stagnant loss in your portfolio.

Tax loss harvesting involves selling a security at a loss and buying another with similar investment potential for 30 days. Afterward, you sell this security to revert to the original investment. This strategy is often employed to offset potential short-term capital gains taxes while maintaining a fully invested portfolio. Let's consider an example.

Suppose you own Ford (F) stock, currently down 20%, and you want to reduce your tax burden from trading Tesla this year. You could sell Ford and buy General Motors (GM), then, after 30 days, sell GM and repurchase Ford. GM would be an apt substitute because both companies are similar (both are automakers) and have comparable stock betas (indicating similar movements to general S&P market trends). Holding a stock like GM instead of Ford for 30 days can potentially leverage any significant market fluctuations, either up or down, when you switch back to your original position.

A crucial aspect of tax loss harvesting is adhering to the wash sale rule. This rule mandates buying a different stock than the one you've sold and not trading out of the new stock before 30 days have passed. Violating this rule forfeits the tax benefit. All tax loss harvesting must also be completed before the end of the calendar year, December 31st.

While tax loss harvesting is a valuable strategy, it's not suitable for every situation. For instance, if you hold a volatile stock like Tesla, trading out of it might cause you to miss a significant upward market movement, which other alternatives may not capture. When tax loss harvesting, it's vital to understand the market trend of a specific security and anticipate potential changes over the next 30 days. This strategy is most beneficial when you've incurred substantial capital gains, as losses can offset your total capital gains and up to $3,000 against future gains in a tax year.

In summary, tax loss harvesting can be an effective component of your overall wealth management strategy, but it's not a one-size-fits-all solution. We recommend consulting with a financial advisor or tax professional when considering how to maximize your losses.

This is not investment advice.