Tax Loss Harvesting

While no one likes to see red ink in their investment portfolio, market volatility often presents opportunities to harvest valuable tax losses that will offset capital gains in other parts of the portfolio. Happily, most clients’ holdings have appreciated to such an extent over time that, despite the volatility of the past few months, they still have very healthy gains. However, if we put new cash to work in your portfolio earlier this year, you may have noticed transactions in your taxable investment accounts during July or August.

The logistics of capturing tax losses are somewhat complicated because of the wash sale rule, which precludes our repurchasing, for at least 30 days, a position we have sold to capture a tax loss. Since we are careful to maintain the asset class exposure during even this brief period, we choose another source of exposure to the asset class.

Due to short-term redemption penalties levied by many mutual funds, we typically use exchange-traded funds (ETFs), which are low-cost baskets of stocks that replicate an index and can be traded at any time during the day. Once the wash sale period has lapsed, we generally sell the replacement ETF and repurchase the original position. Sometimes, however, investment markets appreciate so strongly during the 30 day wash sale period that it is preferable to hold the replacement ETF rather than realize a large short-term capital gain. In these cases, we’ll often retain the ETF for a year to get the benefit of long-term capital gain rates or, in some few cases, indefinitely if ETF performance has been so strong that selling it and realizing the taxable gain would, in our estimation, offset much of the advantage of returning to the original position.

Since we are committed to optimizing after-tax returns for our clients, we will continue to capture all significant losses (typically 5%-10%, depending on the asset class) that present themselves. This serves as one of many portfolio management techniques we use to attempt to optimize our clients’ investment results.