It’s been a painful run. Anyone watching the market lately – or peeking at statements – likely experienced discomfort. Inflation has rocketed. Instability around the world has rattled investors. The Fed’s quarterly Beige Book has been fraught with fearful sentiment. But for savers with a taxable brokerage account, downturns create opportunity.
When equities dip, investors with a taxable brokerage account can take advantage through tax-loss harvesting. I know. It doesn’t sound great. Take losses? In reality, selling equities at a loss creates a few critical tax advantages for the future.
Let’s start with the first benefit. Sell an investment at a loss and you can use that loss to offset capital-gains realized. And the more you harvest, the more prospective taxes you can avoid. Here’s an example: say you have a mutual fund with cost basis – the amount you paid for the respective shares – of $100,000. Market dives. Within a few months, your $100,000 investment is down to $75,000.
Despite the sting, if you sell the fund when it is down, you can reap that $25,000 loss and – almost immediately – reinvest the funds in a not-too-similar investment (or risk triggering a wash-sale . . . more on that later). Essentially, this will reset your cost basis in the new investment to $75,000.
Over time, you may need to sell that fund to pay for a vacation or a new car. Pretend you sell when the investment is now worth $90,000, as the market recovery is underway. Though you will realize a $15,000 gain on the second sale, you will not be subject to capital-gains tax, as the $25,000 loss previously realized will erase the ensuing gain. Even better, you still have $10,000 of capital-loss carryforward in your back pocket to offset future gains.
It gets better. If you hold mutual funds that pay capital-gain distributions at year-end, realized losses can be used to wipe them out, again avoiding exposure to a taxable event. And the cherry on top? Any realized losses not used in the current year can be carried forward. FOR-EH-VER (channeling, Smalls). Well, until you die. But for investors who build large taxable accounts, the benefit of tax-loss harvesting can be enjoyed for years. For example, if they harvest $250,000 in losses during a severe bear market, these investors can avoid a matching amount of gains. Depending on their needs and growth of the security, they may be able to avoid capital-gains tax through the foreseeable future.
A word of caution: do not invest proceeds from the tax-loss harvesting sale (the first sale in the former example) in a too-similar investment. Doing so would trigger the wash-sale rule and you could risk negating portions of the loss and limit potential tax benefits. This issue can be easily avoided when using mutual-funds (though best to consult with your advisor to ensure this does not occur), but if toying around with individual stocks, make sure you did not buy the security within the past 30 day or purchase it again for 30 days. Or else the IRS will not be happy.
Whew. That’s a lot. If it created any questions, feel free to reach out. Or if you have any topics you’d like to see covered, hit me up. I’m around.
Tim Neuenschwander, CPA, CFP® is the managing member of Neuenschwander Asset Management, LLC. You can click on his name to visit his LinkedIn profile or you may contact him via email at tim@namadvisors.com
Christine joined the NAM team in 2020, along with her six-plus years of Administrative and Executive Assistant experience. She was born and raised in Wisconsin. She has a love for film, comedy writing, and music, particularly between the 50’s and 80’s.
During my salad days, I studied business at the University of Minnesota and the Carlson School of Management. Taking this route seemed to make sense when I graduated high school, as it offered the opportunity to pursue a career in business. However, the experience didn’t go as planned. I found myself disillusioned by the focus and teachings of business school, with many of the lessons revolving around detached relationships focused solely on profit. I eventually concluded that this was not my personal path. I chose instead to purse a passion – writing – and veered off into journalism for the next six years of my life.