Tax Loss Harvesting

Tuesday, December 12th, 2017

Good Morning Relaxing Retirement Member,

When December rolls around, it’s always a smart time to see if you can benefit from “tax loss harvesting” before the clock strikes midnight on December 31st. This is a process we’re in the middle of for our members right now.

By tax loss harvesting, I mean utilizing any unrealized losses or unused capital losses that you have realized in prior years (and potentially this year), to reduce your income tax burden this year.

While nobody likes to see, and certainly not “realize” a capital loss, the great news is you can recover a 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 $100,000 and later sold all of it for $165,000, you would owe capital gains taxes on the growth, i.e. $65,000.

On the flip side, however, if you purchased a stock or stock fund for $100,000 and later sold all of it for $85,000, you can declare a capital loss of $15,000.

That $15,000 capital loss, while painful to realize, has significant value if handled properly. For example:

  1. You may use it to offset $15,000 of capital gains you realized in the same year, thus eliminating taxes on $15,000 of capital gains. This saves the average taxpayer a minimum of $2,250 in federal taxes, not to mention state taxes here in Massachusetts.
  2. If you don’t have $15,000 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 ($12,000) over to next year and continue the same strategy. If you have a $12,000 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 $9,000 over to the following year.

Opportunity

If you sold any investments in the past thus “realizing” 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 2016 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 2017 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 have 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 using the wash rule.

With the rise in price of virtually every asset class this year, it’s unlikely that many of your holdings are worth less today than your cost basis. However, this is a discipline and exercise we continue to go through each year because everyone’s situation is a little different, and we always want to explore all potential opportunities.

Committed To Your Relaxing Retirement,

Jack Phelps
The Retirement Coach

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I appreciate the trust you place in us.  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.)