Harvest the silver lining
We have introduced the basics of saving taxes on your investments that have gone down. This exercise, called tax loss harvesting, is the silver lining of an otherwise gloomy market. Sometimes, however, you should just leave well enough alone. We will discuss it today.
In a nutshell, tax loss harvesting is selling a security that has a net loss in order to realize the loss on your taxes. These losses can be used to offset other gains or to protect certain ordinary income from tax.
Since you probably own the title because you believe in its future, you immediately replace it with a very similar one. If only this specific security suffices, you will replace it exactly 30 days before or after the sale of the tax loss. (For more discussion on this, see last week’s column.)
While this may sound like a great idea, it’s important to realize that even if you get the tax loss now, you’re building up a bigger future tax bill. Here’s why. Let’s say the Netflix stock you bought for $4,700 is now only worth $1,700. Selling it now locks in that $3,000 loss, giving you some nice tax savings. However, we’ll assume you still think Netflix is a good title to own, so you buy it back several weeks later (avoiding the bogus sale rules discussed last week). For our purposes, suppose you buy it back at the same price of $1,700 at which you sold it.
Now, five years later, in 2027, you look at your brokerage statement and see that Netflix is now worth $8,700. Yes! From your initial purchase of $4,700, you made a profit of $4,000. It’s time to cruise, so you’ll sell off your stock and enjoy the Western Caribbean.
Come tax time, you realize that you’re not going to pay taxes on a $4,000 gain: you’ll pay taxes on a $7,000 gain. Do you remember that $3,000 loss you suffered? This not only offered you a nice tax saving; it also reset your cost base when you redeemed the stock. So, as you can see, tax loss harvesting tends to delay taxes, not get rid of them.
Still, that might not be a bad thing; especially if you use current tax savings to invest more money or if your current tax bracket is higher than your future one.
There is also another potential benefit: you could die. Okay, so most of you might not see this as a benefit, but under current tax rules, your heirs will see your reduced cost reset to the value of the stock when you die. If you’re “lucky” you can get your tax deduction now and maybe no one will pay taxes on later gains.
This, like all other tax matters, is more complicated than I do. Be sure to consult your tax advisor before doing anything you may end up regretting.
May Ukraine remain free.
Gary SilvermanCFP® is the founder of Personal Money Planning, LLC, a Wichita Falls retirement planning and investment management firm and author of Investing in the real world.