Welcome to another installment of the Master’s Minute! Through our comprehensive Total Wealth Management planning process, during the fourth quarter of the year, we analyze various tax planning strategies to determine which would be best to consider utilizing to optimize each client’s individual income tax situation.
Our gratitude series last month ended with some particularly timely advice on improving the impact of your giving and ensuring the best tax advantages for your gifts.
Today’s blog focuses on a strategy that can be particularly beneficial for our clients in higher tax brackets: Tax-Loss Harvesting.
Let’s dive in!
Defining Tax-Loss Harvesting
Tax-Loss harvesting is a strategy that involves intentionally selling investments that have declined in value. This allows investors to realize the loss during the current tax year, and either offset realized capital gains or reduce their taxable income.
However, there are some very important nuances to consider before executing this strategy.
Essential Nuances When Considering Tax-Loss Harvesting
There are several important nuances that must be taken into account with this strategy. We’ve chosen three of them to highlight below, those include tax bracket, timing and rules, and anticipated withdrawals.
Let’s explore these considerations in depth.
Tax Bracket
This strategy has a greater impact for clients in higher tax brackets, such as the 24%, 32%, 35% or 37% ordinary income tax brackets.
There are a few reasons for this.
First, virtually all clients in the 10% or 12% tax brackets (with some exceptions) are in the 0% tax bracket for capital gains and, therefore, get to realize capital gains with no income tax impact.
In contrast, clients in higher tax brackets pay 15%, 18.8%, or 23.8% on realized capital gains. As a result, realizing losses to offset gains can make a noticeably positive impact at tax filing time for clients in these brackets. However, for clients in lower tax brackets, this strategy is not as impactful.
If you are interested in understanding the U.S. tax bracket system, as illustrated with a simple analogy, please visit our blog explaining the tax brackets.
Timing & The Wash Sale Rule
The timing of this strategy is extremely important, because mistakes can negate the intended outcome.
The IRS has a rule known as the wash sale rule. This means that they will not permit losses to be realized in a security (or equivalent security) that was purchased within 30 days before and after the date of the loss harvest.
More specifically, the amount of the purchase results in an equivalent amount of losses being “washed,” meaning they will be unable to be realized on the tax return.
As a result, when we harvest losses in a security, we invest the proceeds in another security that is not deemed substantially identical to the one harvested. After the expiration of the wash sale window (31 days after the trade date), we reposition the proceeds back into the original security.
Anticipated Withdrawals
Another important matter to consider is any anticipated withdrawals from the account in the next year.
When we buy back the original security after the expiration of the wash sale window discussed above, this restarts the time clock on capital gains for this specific lot of the security.
Therefore, any future sales within a year of the repurchase date will be deemed short-term capital gains. Short term capital gains are taxed at ordinary income tax rates and not the more favorable long-term capital gains rates.
A Valuable Strategy for Many Higher Income Households
As you can see by now, tax-loss harvesting can be a very valuable tax planning strategy to deploy for our higher income clients.
However, great care must be taken when evaluating the strategy for each client and while executing the strategy in order to ensure the strategy results in the intended outcome. The Master’s team takes pride in our attention to detail and our diligence in executing these types of planning strategies for the benefit of our clients and their families!
Feel free to contact us today to discuss your unique situation or any questions you may have.
