With the market veering into a period of volatility, advisors say timing is going to be key for clients who hope to ease the pain with tax-loss harvesting,
Such harvesting can be tricky in a generally bullish market that sharply turns to the downside, they say.
“In a continuously booming market, where asset values are rising, identifying and realizing losses becomes very difficult because fewer investments are likely to be in a loss position,” said Paul Miller, CPA and managing partner at Miller & Co. in New York.
One factor in effective loss harvesting is the holding period. “An active trader can really take advantage of tax loss harvesting, but the challenge is when an investor has owned a stock for many years,” Balcer said. “The stock might be down 50% year-to-date but if bought years ago and it’s appreciated several hundred percent, it would still have a significant unrealized gain despite recent losses.”
Tax-loss harvesting is a common investment strategy that allows investors to offset capital gains capital losses within a current tax year. (Excess losses up to $3,000 per year created by the sale of securities can also be carried forward indefinitely.) The idea is to sell laggard equities and replace them with better-performing ones – though not performers better than the stocks sold, so as to avoid 30-day wash sale prohibitions.
Historically a year-end tax move, the strategy is becoming more popular year-round.
“Clients who expect to be in a high tax bracket this year but not in future years are particularly suited for tax loss harvesting. They can take advantage of the losses when they’re going to be taxed at a higher rate,” said Marc Balcer, senior VP and director, Investment Strategy at Girard.
Special attention is needed to guide clients through this intricate tax planning, advisors say.
Help clients “pick a selling point of a stock that you can live with the loss and pick a point where you think you may have maximized your gain,” said James N. Mohs, associate professor of accounting at the University of New Haven in West Haven, Conn. “Think twice about the reasons you hold the securities [before] you issue your sell order.”
“Diversify into different asset classes such as bonds, mutual funds and so on, as there may be opportunities present for harvesting losses beyond just stocks,” Miller said. “Even in a booming market, there may be individual securities or industries that have lagged.”
Even with “the narrowness of the market and strength among Magnificent 7 stocks, there are still many companies that have experienced declines so far in 2024,” Balcer added. “For example, just under 30% of S&P 500 stocks were down year-to-date through July 30. And this impact is even larger as you move down in market capitalization. Forty-two percent of the small cap Russell 2000 constituents have seen declines.”
“It appears the bond funds are creating losses, so those type of funds may be good candidates for loss harvesting,” said Larry Pon, a CPA and advisor in Redwood City, Calif.
Unconventional tactics might help a client’s tax situation, advisors say.
“Tax-loss harvesting doesn’t eliminate tax liability, just pushes it into the future,” Balcer said. “For some investors who may have lower capital gains tax rates in the future as income levels fall in retirement, it may not pay to aggressively harvest losses.
“Appropriately allocating assets across taxable and tax-efficient accounts can make a major impact,” Balcer added. “This could mean holding taxable bonds in an IRA that holds long-term stock investments in regular taxable accounts. Also valuable is being very thoughtful about spending strategies, especially when in retirement3making sure to withdraw from accounts that won’t trigger tax liabilities.”
“Use carried forward losses from previous years to offset current year gains, optimizing [clients’] tax position even if new losses are harder to find,” Miller said. “Consider donating appreciated securities to charity ... since this may provide a tax deduction while avoiding capital gains taxes.”
Gifting can dovetail with harvesting gains instead, manipulating already favorable (compared with income tax) capital gains rates, Pon said. “These capital gains tax brackets are based on taxable income [so clients] have more flexibility to lower capital gains brackets by increasing charitable deductions,” he said.