Take Advantage of Corrections with Tax-Loss Harvesting

Right now, taking losses on investments may be particularly attractive – even if you don’t have any gains to offset. Selling investments that have declined in value can be a worthwhile tax-saving strategy anytime, but it may be particularly smart this year, due to recent stock market corrections. This strategy – known as tax-loss harvesting – involves the sale of stocks, bonds, and mutual funds that have lost value to help reduce taxes on capital gains from profitable investments.

For investors who realized capital gains last year, recent market declines provide the opportunity to offset a significant portion of those profits. Even if you lack gains, selling depreciated investments after a correction can generate losses that can be carried forward to offset future gains, or reduce current ordinary income by as much as $3,000. Tax-loss harvesting can be a useful strategy for both active traders and those performing an annual portfolio rebalancing. Rebalancing helps to ensure that your mix of stocks, bonds, and other investments is appropriate for your investment time frame, financial requirements, and tolerance for risk. When prices have declined, portfolio rebalancing can generate opportunities to reduce your tax bill, while simultaneously bringing your holdings back in line with your investment goals. No matter what type of investor you are, planning ahead and evaluating a tax-loss harvesting strategy can improve your results.

How much can tax-loss harvesting reduce your taxes?

The extent to which you may benefit from tax-loss harvesting is dependent on your income level and capital gains, minus any current losses or losses carried forward from previous years. Short-term capital gains are realized from investments with duration of one year or less, and they are taxed at the same marginal rate you pay on ordinary income. The top marginal tax rate is currently 39.6%. In 2016, it’s estimated to apply to couples filing jointly with income over $466,950, and single taxpayers with income exceeding $415,050. For those subject to the 3.8% net investment income tax (NIIT), the effective rate can be as high as 43.4%. When you consider state and local income taxes, the rates get even higher.

Long-term capital gains are those realized from investments held for over one year, and are taxed at significantly lower rates. In fact, you won’t owe any taxes at all if you have a 2016 taxable income below $75,300 and you are married filing jointly, or $37,650 if you are a single filer. For most taxpayers – those with a taxable income between $74,901 and $466,950 (married, joint filers) and $37,451 and $415,050 (single filers) – the long-term capital gains rate is 15%.

High-income taxpayers, however, face higher rates. If your taxable income exceeds $466,950 (married joint filers), or $415,051 (single filers), your marginal rate for long-term capital gains is at least 20%.

Again, when the 3.8% NIIT is triggered, the actual long-term capital gains tax rate for high earners can be as much as 23.8%, and the actual rate applied to other investment income can be as high as 43.4%. The NITT is levied on the lesser of net investment income, or the amount by which modified adjusted gross income (MAGI) exceeds $250,000 for couples filing jointly, and $200,000 for single filers.

Prioritize Your Tax Savings

Maximize your tax savings by applying as much of your capital loss as possible to short-term gains, since they are taxed at a higher marginal rate. Per the tax code, losses must first be used to offset gains of the same type, but realizing a capital loss can still be effective – even if you lack realized capital gains this year. That’s because up to $3,000 per year in capital losses can be applied against ordinary income, which is taxed at the same rate as short-term capital gains and nonqualified dividends. Furthermore, if there are still capital losses after first applying them to capital gains and then to ordinary income, they can be carried forward for use in future years. The least-effective implementation of a tax-loss harvesting strategy would be the application of short-term capital losses to long-term capital gains, but that may still be preferable to paying the long-term capital gains rate.

Steps To Take Now

If you’re thinking of implementing a tax-loss harvesting strategy in order to offset a portion of your gains, you should carefully research your records regarding any asset you are considering selling. You should also assess how changes in the value of your holdings have impacted your investment mix. Regular portfolio rebalancing is necessary to keep your portfolio aligned with your goals, since it provides an opportunity to reexamine laggards that may be candidates for tax-loss harvesting. Tax planning – including tax-loss harvesting – should be a year-round activity, and keeping good records will help you track your cost basis, and anticipate any capital gains tax liability well before year-end.

It’s also important not to forget about wash-sale rules.  If you sell a security at a loss you cannot repurchase that same security for thirty days.  You can also not have made an additional purchase thirty days prior to recognizing the loss.

Rebalancing does not guarantee a return or protect against a loss. The buying and selling of securities for the purpose of rebalancing may have adverse tax consequences.

Investment advisory services provided by Werba Rubin Wealth Management, LLC (“Werba Rubin”). Securities transactions are offered through a non-affiliated entity, Loring Ward Securities Inc., member FINRA/SIPC. WR 16-046


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