Tax-loss harvesting is a popular planning move that people usually consider at the end of the year, but advisors say clients should also be looking at these moves throughout the year. That’s because the regulations regarding these tax moves are tricky, and clients have to think ahead about reinvesting money to serve their long-term goals.
Annual loss harvesting is standard strategy among investors because it can offset capital gains earned during the year, and excess losses can offset up to $3,000 of ordinary income. Additional losses can be carried forward into future years.
But advisors say a yearlong approach to loss harvesting allows investors to adapt their strategy to market volatility.
“There are multiple reasons to do it on a more continuous basis,” says Erik Preus, head of investment solutions at Envestnet PMC in Minneapolis. “Think of 2020, when there was a big market decline when the pandemic first hit. After that harsh decline, the market recovered quite strongly for the rest of the year. Had investors waited until the end of the year to harvest losses, they may not have had nearly as much tax savings.”
Part of the reason this is an ongoing process is the wash-sale rule, which forbids a loss deduction for a security sold and then repurchased or replaced by a too-similar security within 30 days. That means if clients harvested losses in late 2022, now is the time that they may need to be thinking about following up and reinvesting that money, says Alan B. Gubernick, a partner at EisnerAmper in Philadelphia. It’s important, he says, “to make sure that after the wash-sale window that the cash is reinvested to re-establish long-term model goals.”
That means “investors must identify and purchase a replacement position for every loss-harvest trade,” says Robert Dietz, national director of tax research at Bernstein Private Wealth Management in Minneapolis. “Holding cash while waiting out the wash-sale period is an unacceptable drag on performance.”
Timing is key, adds Marc Balcer, a senior vice president and director of investment strategy at Girard, a Univest Wealth Division, in King of Prussia, Pa.
“One of the benefits of doing tax-loss harvesting throughout the year is that you are not doing it when everyone else is doing it—in December,” Balcer says. “The worst-performing stocks often decline further in late December as tax-loss harvesters do their work. This can provide a rally in January in those same stocks that one couldn’t capture because they need to wait for the wash-sale period to expire.
“We have clients expecting significant capital gains elsewhere in their investment portfolio, for example with the sale of a vacation home,” Balcer says. “These can be important opportunities to seek out tax loss candidates to offset those gains and smooth out income over years.”
Tax-loss harvesting must continuously align with a portfolio’s overall strategy and “may also be an opportunity to realize losses with investments that no longer align with the strategy or allocation,” says Thomas Pontius, financial planner with Kayne Anderson Rudnick in Los Angeles. “Losses due to short-term volatility shouldn’t be constantly sold and bought back into [a portfolio] in an attempt to drive tax value, due to the potential of missing out on [constant] growth in the investment.”
Loss harvesting shouldn’t be an automatic go-to, says Sophia Duffy, a CPA and associate professor at the American College of Financial Services in King of Prussia, Pa.
“For example,” she says, “if the investor plans to sell the investment in the next 12 months, any realized gains will be taxed at ordinary income tax rates, not long-term capital gains rates, which are usually lower.” If the markets later improve, she says, the client may simply owe taxes on gains realized later.
Don’t take every loss you can, advisors say, especially if you’re in a lower tax bracket but expect to be in a higher one down the road.
“When you harvest losses, you’re moving the portfolio away from its target state,” Preus adds. “That could create a portfolio that performs very differently from expected.”