There are two certainties in life, according to the famous expression: death and taxes. And while we can’t avoid the former, we can reduce the latter through tax-loss harvesting.
Tax-loss harvesting is a strategy to lower your tax bill by selling securities you’ve lost money on to offset taxes from sales of stocks you’ve made money on.
“If you sell a stock within the portfolio at a gain, that event may be taxable,” says Frank Delia, Truist financial advisor. “Through tax-loss harvesting, you can take strategic losses when necessary to reduce that tax bill at year-end.”
By managing the buys and sales inside a portfolio to be tax-efficient, Delia says, investors can keep more of what they earn. And reinvesting those tax savings can add a lot to a portfolio’s value over the long term.
A closer look at tax-loss harvesting
Simply put, tax-loss harvesting offsets the taxes on capital gains—your profits from a stock sale—by selling off stocks that are showing a loss. The IRS allows a deduction of up to $3,000 in capital losses in a single tax year (additional losses can be carried forward into subsequent years).
Let’s see it in play:
You’ve invested in Security A and Security B. At year-end, Security A’s value has increased, and you have a realized gain of $7,000. If the $7,000 in gains is taxed at 15%, the resulting tax bill is $1,050.
Meanwhile, Security B has an unrealized loss of $3,000. You can continue to hold the position and wait for its value to increase, or you can realize the loss (read “sell”) and apply that amount against profits from Security A, leaving you with a taxable gain of only $4,000. Taxed at 15%, your new tax bill would be $600. That’s a savings of $450, which you can reinvest or spend at your discretion.
Here’s a handy visual of the same scenario:
Avoiding wash sales
When you sell an asset to harvest the loss, you might want to purchase the same asset, or one that’s considered “substantially similar,” later. But investors are barred from purchasing the same or a substantially identical security 30 days prior to or 30 days after selling it for a loss. If that rule is broken, a so-called wash sale is triggered, and you cannot claim the loss on the original sale.
The IRS goes through a rigorous review of your assets to ensure a wash sale hasn’t occurred. They review all securities you own, securities your spouse owns (if applicable), and securities held by any of your businesses. If the wash sale rule is abused, the IRS can impose penalties and restrict your trading.
Automated tax-loss harvesting
Manual tax-loss harvesting can be a meticulous and time-consuming process—not to mention costly if it’s performed by a financial advisor. Avoiding wash sales adds another layer of complexity.
Yanette Sullivan, a financial advisor with Truist’s Client Advisory Center, has had her fair share of client meetings to determine the best way to offset gains.
The Truist Invest platform can handle tax-loss harvesting automatically, she says. Truist Invest—and other robo-advisors like it—continually seek opportunities to realize losses that offset taxable gains elsewhere in a portfolio. The algorithms they use identify and avoid wash sales when rebalancing and are impactful for accounts as small as about $20,000.
As a result, tax-loss harvesting through Truist Invest is simpler and more cost-effective than it would be with a financial advisor. And that means, Sullivan says, “You can really focus on your goals as opposed to taxes.”