Year end tax planning does not need to include tax loss harvesting
Donâ€™t do tax loss selling just because you can
For all the good reasons that you might want to engage in tax-loss harvesting as part of your year end tax planning, keep in mind some of the mistakes that people make.
What is "tax loss selling" (a.k.a. tax loss harvesting)?
At year's end, investors and their financial advisors often browse through their portfolio to see what positions are currently at a loss. They then sell those positions, changing their status from an “unrealized” loss to a “realized” loss. Once you have realized the loss, you can use that loss as part of your year end accounting. For example, let’s say you owned and sold two different stocks. One you sold for a $1000 profit and the other one you sold for a $1000 loss. Your net taxable income would be $0, since the realized loss would offset the realized gain. That sounds smart, but ask your tax advisor and/or financial advisor before you make any transactions since there are some reasons not to sell at a loss (and this article is in no way a substitute for proper tax or investment advice; it’s just a friendly heads-up for you).
Here’s why you should not do tax loss selling:
- If you buy back the security that you sold within 30 days, that’s called a “wash sale,” and your realized loss would be disallowed by the IRS. I had a client who sold a stock for a loss, but when the stock started creeping back up the next day because the company announced some good news, he got anxious. He jumped back into the position and then could not use the tax loss. He ended up losing money by paying extra commissions .
- Although selling a position at a loss allows you to offset taxes on capital gains that you have, you cannot know what your tax situation will be like in the future. With the rapidly increasing U.S. debt, it appears that tax increases will be necessary to help pay it off. If the government raises your tax bracket to 50% next year, wouldn’t you rather be able to use that loss against capital gains in the future. No one knows what the tax man’s bite will be in the future, but it certainly looks like he’s growing a big set of choppers.
- Don’t get so excited about the prospect of saving taxes and let the tax tail wag the investment dog. In other words, a position that you are holding at loss might actually turn around and go up. When? Who knows? But if you sell it just to capture the loss, you won’t benefit from the recovery. Are there any sectors that have been beaten down that you think are on their way up? The whole point of investing is to buy when something is low; if you sell to engage in tax loss harvesting you are doing just the opposite – selling when low. Buying high and selling low won’t make you rich, no matter how much tax you save.
Disclaimer: This article is for educational purposes and is not a substitute for investment advice that takes into account each individual's special position and needs.