Good Sportsmanship: How to Take a Loss with Tax Loss Harvesting

At Drexel and Co. Financial Planning, we know that losses in investing can be disappointing, but they can also present valuable opportunities to optimize your portfolio and reduce your tax liabilities. Tax loss harvesting is the strategy of making the best out of a bad situation—leveraging investment losses to offset gains and lower your taxable income. Here’s how to take a loss like a true financial sportsman.

What is Tax Loss Harvesting?

Tax loss harvesting involves selling underperforming investments at a loss to offset gains from other investments or reduce taxable income. This strategy can help you:

• Lower your tax bill by offsetting short-term or long-term capital gains.

• Use up to $3,000 of losses annually to offset ordinary income.

• Carry forward unused losses to future tax years.

By turning an investment loss into a tax-saving opportunity, you can keep your financial goals on track while maintaining good sportsmanship in the face of market challenges.

The Basics of Tax Loss Harvesting

1. Identify Underperforming Investments

Work with your financial advisor to review your portfolio and identify investments that have decreased in value. These losses can be “harvested” to offset capital gains from other investments.

2. Offset Capital Gains

Capital gains are taxed differently depending on whether they are short-term (held for less than one year) or long-term (held for more than one year):

• Short-term gains: Taxed at your ordinary income rate.

• Long-term gains: Taxed at a lower capital gains rate.

Tax loss harvesting allows you to strategically offset gains from both categories, minimizing your overall tax burden.

3. Carry Losses Forward

If your harvested losses exceed your gains, up to $3,000 can be used to offset ordinary income each year. Any remaining losses can be carried forward indefinitely to offset gains in future years.

Key Rules to Follow

The Wash-Sale Rule

The IRS wash-sale rule prohibits you from repurchasing the same or a “substantially identical” investment within 30 days before or after the sale. Violating this rule disqualifies the loss for tax purposes.

Example:

If you sell shares of a stock at a loss, you cannot buy the same stock (or an ETF tracking the same index) within the wash-sale window. However, you can purchase a different, but similar, investment to maintain your portfolio’s exposure.

Tax Loss Horror Story: The Robinhood Trader

One of the most infamous stories in recent years highlights the potential risks of poor tax management. A young trader using Robinhood reportedly racked up an $800,000 tax bill despite having a net loss of $16,000. How did this happen? The trader engaged in frequent buying and selling of stocks, creating substantial short-term capital gains, but did not account for wash-sale rules or other tax implications. When it came time to file taxes, the wash-sale adjustments disqualified many of his losses, leaving him with an astronomical tax liability. This story underscores the importance of working with experienced financial advisors who understand tax-efficient investment strategies.

Benefits of Tax Loss Harvesting

1. Immediate Tax Savings: Reducing taxable gains lowers your tax bill in the current year.

2. Portfolio Rebalancing: Selling underperforming investments allows you to reinvest in assets better aligned with your financial goals.

3. Long-Term Tax Efficiency: Carrying forward unused losses creates opportunities for future tax savings.

When to Consider Tax Loss Harvesting

• End of Year: Many investors implement this strategy in December to optimize their tax position for the year.

• Market Downturns: Significant market declines may present opportunities to harvest losses.

• Regular Portfolio Maintenance: Periodic portfolio reviews can uncover tax loss harvesting opportunities.

Limitations and Risks

While tax loss harvesting is a valuable tool, it’s not without limitations:

• Wash-Sale Restrictions: These rules require careful planning to avoid disqualification of losses.

• Market Timing Risks: Selling an investment at a loss may lock in a loss if the asset’s value subsequently rebounds.

• Tax Efficiency vs. Investment Goals: Overemphasis on tax efficiency can lead to deviations from your long-term investment strategy.

Good Sportsmanship in Financial Planning

Just as good sportsmanship is about maintaining composure and seizing learning opportunities from defeat, tax loss harvesting is about turning a loss into a win. By strategically managing investment losses, you can enhance your financial resilience and position your portfolio for future success.

How Drexel and Co. Financial Planning Can Help

At Drexel and Co., we specialize in personalized tax-efficient investment strategies. Unlike many financial advisors who outsource tax management to third-party firms, we manage your investments directly and take full responsibility for the outcomes. Our experienced advisors:

• Monitor your portfolio for tax loss harvesting opportunities.

• Ensure compliance with IRS rules, including the wash-sale rule.

• Align tax strategies with your overall financial goals.

Contact us today to learn how tax loss harvesting can play a key role in your financial playbook. Let’s turn market losses into a winning strategy for your future.

Citations

1. IRS. (2023). Tax Loss Harvesting and the Wash-Sale Rule. Retrieved from https://www.irs.gov

2. CNBC. (2021). Robinhood Trader May Face $800,000 Tax Bill Despite Losing Money. Retrieved from https://www.cnbc.com

3. Investopedia. (2023). Tax Loss Harvesting Strategies. Retrieved from https://www.investopedia.com

4. Financial Planning Association. (2023). The Importance of Tax-Efficient Investing. Retrieved from https://www.financialplanningassociation.org