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Tax Loss Harvesting: Key Insights on Turning Investment Losses into Tax Savings

Selling securities at a loss to offset capital gains, commonly referred to as Tax Loss Harvesting, is a tax savings strategy that many associate with year-end tax planning. However, to truly maximize one’s tax savings, a taxpayer should be attentive throughout the year to potential tax loss harvesting opportunities that may arise. Given the recent market volatility, now may be the ideal time for taxpayers to realize built-up losses in their investment portfolio and harvest those tax losses.

To maximize the benefits of tax loss harvesting, it is important for taxpayers to be aware of the various tax rules that need to be considered before executing seemingly innocent transactions. Running afoul of these tax rules can minimize, or potentially even negate the intended benefit of the executed tax loss harvesting transaction. Conversely, with proper planning and consulting with your tax advisor, transactions can be structured in a manner that can generate additional tax benefits beyond just tax loss harvesting.

The following are some tax considerations when contemplating tax loss harvesting transactions.

Wash sales

Taxpayers may be tempted to sell a stock to realize a loss and then shortly thereafter repurchase the same (or substantially identical) stock in order to have exposure to any future appreciation of the stock. This would not be a viable tax loss harvesting technique since the wash sale rule disallows a loss resulting from the sale of stock or securities if, within a 61-day period beginning 30 days before the sale of the stock or securities, the taxpayer acquires, or enters into a contract or option to acquire substantially identical stocks or securities.

With proper tax planning and structuring of transactions, there are various options available that would allow the taxpayer to realize the loss on the sale of the stock while maintaining their exposure to the stock; thereby circumventing the wash sale rules.

Short-term versus long-term losses

Long-term capital losses are used to offset long-term capital gains before they are used to offset short-term capital gains. Similarly, short-term capital losses are used to offset short-term capital gains before they are used to offset long-term capital gains. Long-term capital gains receive preferential tax treatment with a maximum federal tax rate of 20% as opposed to short-term capital gains that are taxed at a maximum federal tax rate of 37%. Therefore, harvesting a short-term capital loss will potentially generate a greater tax savings since it will be used to first offset a short-term capital gain that would have been taxed at a much higher rate than a long-term capital gain.

Working with your tax advisor, creative solutions may be employed to enable you to convert long-term capital losses into short-term capital losses, which can then be harvested to offset short-term capital gains.

Hedged positions

Extra caution should be exercised when considering tax loss harvesting through the sale of a security that is hedged with an offsetting position. Positions are considered offsetting if there is a substantial diminution of the taxpayer’s risk of loss from holding one position by reason of holding the other position. A common example of a security that is hedged with an offsetting position is when a taxpayer owns a stock and at the same time the taxpayer has a short position in that very same stock, anticipating that the stock price will go down. In such a scenario, if the taxpayer were to sell the stock for a loss, the unsold offsetting short position would have moved in the opposite direction and have an unrealized gain. However, under some complex and onerous straddle rules, the stock loss would be deferred until either the offsetting short is sold or no longer has an unrealized gain.

State tax limitations

There is no limit to the amount of tax losses that can be harvested. However, individual taxpayers may use up to $3,000 of total capital losses in excess of total capital gains on their personal tax return in any given tax year as a deduction against ordinary income. Any excess capital loss is carried forward indefinitely to offset the individual taxpayer’s future years’ capital gains. While many states conform to the federal capital loss carryforward rules, there are a small number of states, such as New Jersey and Pennsylvania, that do not conform to the federal rules and do not permit capital loss carryforwards. Taxpayers that reside in such states which do not allow capital loss carryforwards should be cognizant of this limitation and only harvest losses up to their current year’s capital gains.

Your overall economic objectives

While it is imperative to incorporate a tax efficiency strategy into the economic goals of your investment portfolio, it is just as important to realize that tax loss harvesting, and any other tax saving techniques, need to work in tandem with your overall investment strategy. In addition to the tax issues previously discussed, there are various economic considerations that should be addressed, such as a taxpayer’s overall trading and investment strategy and the transaction costs associated with any tax strategies employed. Working closely and collaboratively with your trusted tax advisor will enable you to formulate a tax-efficient strategy that will simultaneously maximize your tax savings and help you achieve your investment goals.

Tax planning and the implementation of tax loss harvesting strategies can be complex. Cautious planning involves more than just a focus on lowering your taxes for the current and future years. There are many things to think about and tax rules to navigate when it comes to tax planning. In most, if not all situations, multi-year modelling may be required to try to maximize tax results today and in future years. Please meet with your tax advisors, who should be able to provide you with a comprehensive review of tax-saving opportunities appropriate for your individual situation and your business. For more information regarding this article or any other tax planning ideas, please contact E. George TeixeiraJeffrey Kahn or your Anchin Relationship Partner.



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