Year-End Tax Harvesting

Wednesday, December 9th, 2015

As we move into December, it’s a great time to see if you can benefit from “year-end tax harvesting” before the clock strikes midnight on December 31st.

By tax harvesting, I mean utilizing any unrealized losses or unused capital losses that you’ve realized in prior years (and potentially this year), to save yourself a bundle in taxes.

As painful as realizing a capital loss is, the great news is you can recover a significant portion of your losses if handled properly.

Unfortunately, most retirees do no planning whatsoever and just pay whatever their accountant tells them to pay.

Let’s quickly review capital gains tax law for a moment so we can clarify where this opportunity lies for you.

Capital Gains Tax Law

As a refresher, for investments you currently own outside of IRAs (you don’t pay capital gains when you buy and sell investments inside your IRA), all “realized” gains are taxed at capital gains tax rates.

For example, if you purchased a stock or stock mutual fund for $50,000 and later sold it for $75,000, you would owe capital gains taxes on the growth, i.e. $25,000.

On the flip side, however, if you purchased a stock or stock fund for $50,000 and later sold it for $40,000, you can declare a capital loss of $10,000.

That $10,000 capital loss, while painful to realize, has significant value if handled properly. For example:

  1. You may use it to offset $10,000 of capital gains you realized in the same year, thus eliminating taxes on $10,000 of capital gains. This saves the average taxpayer a minimum of $1,500 in federal taxes, not to mention state taxes here in Massachusetts.

  2. If you don’t have $10,000 of capital gains to offset, you can use $3,000 of the loss to offset $3,000 of ordinary income you have this year. That would save the average taxpayer approximately $750.
  3. You can then carry the unused portion ($7,000) over to next year and continue the same strategy. If you have a $7,000 gain next year, you can offset the entire tax due. If not, you can offset another $3,000 of ordinary income tax and carry the remaining $4,000 over to the following year.

Opportunity

Had you sold any investments in the past and ‘realized’ a capital loss, you now have the opportunity to recover some of those losses.

Or, if you have any investments held outside of IRAs where the cost basis is higher than the current market value, you have an opportunity to lock in a capital loss right now and use it against your realized gains this year.

Strategy

My recommendation for you is three-fold:

  1. Pull out your 2014 federal income tax return. Take a look at the bottom of Schedule D to determine if you have any unused capital losses carrying forward into this year. And, if so, how much?

  2. Determine if you have any realized gains in your non-IRA accounts so far this year:

    1. Have you sold any of your holdings at a gain, thus already realizing gains in 2015 that you may want to potentially offset?
    2. If you own actively managed stock mutual funds, go to your fund company(s) website and you will typically find year-end “internal” capital gains distribution estimates. Do your best to determine what your short and long term gains will look like.
    3. Do you have any stocks or stock funds that you’ve thought about selling, but you haven’t pulled the trigger because it will carry a large capital gains tax with it?

  3. Take a look at your unrealized gain/loss positions on your non-IRA account statements:

    1. Is the cost basis for any of your holdings greater than the current market value? If so, this may be due to three situations:

      1. The share price is lower today than when you purchased the fund due to market forces, or
      2. The share price is lower today because your fund declared capital gain distributions in the past and you have already paid tax on them, thus raising your cost basis above what you paid for the investment, or
      3. You have been reinvesting the dividends from your fund to purchase more shares over the years, thus raising your cost basis.
    2. If this is true for any of your holdings, you have an opportunity to ‘realize’ a capital loss before year-end (harvesting) and offset any of your realized gains.

Once you’re armed with this information, look for opportunities to offset this year’s gains with prior losses you’ve carried forward, or with losses you could “realize” this year by selling specific holdings, and replacing them with similar holdings.

Harvesting is a critical year end strategy which you can’t afford to let pass you by. The difference could be thousands of dollars of tax savings in April.

Committed To Your Relaxing Retirement,

Jack Phelps
The Retirement Coach

P.S.: WHO do you know who could benefit from receiving my Retirement Coach “Strategy of the Week”? Please simply provide their name and email address to us at info@TheRetirementCoach.com. Or they can subscribe at www.TheRetirementCoach.com. I appreciate the trust you place in me. Thank you! (The content of this letter does not constitute a tax opinion. Always consult with a competent tax professional service provider for advice on tax matters specific to your situation.)