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Clients are often keen to offset their tax liabilities—and Ethic’s sustainable separately managed account (SMA) portfolios can help you to engage in tax optimization on their behalf. Here’s our quick guide to tax-loss harvesting, a vital part of any advisor’s toolbox:
Let’s be honest: most headlines in recent months haven’t exactly been uplifting. The COVID-19 pandemic has exacted a tragic human toll, and the measures introduced to contain its spread have of course slowed economic activity.
Investors initially responded to dire coronavirus-related projections with a massive sell-off in February and March, and volatility has been the name of the game ever since. However, it’s not all doom and gloom—advisors can cushion the blow with tax-loss harvesting, a strategy that may help to offset losses in their clients’ portfolios. This also comes at a time when, as we approach the end of the year, many clients will likely be looking to offset their tax liabilities. Here’s our brief primer on this crucial part of the advisor’s toolbox:
What is tax-loss harvesting?
Quite simply, tax-loss harvesting is the act of selling an investment that has declined in value in order to realize capital losses that can be written off on your tax return. By realizing (harvesting) a loss, investors can offset taxes on gains and income.
Capital losses, of course, occur anytime an asset decreases in value. However, as far as the Internal Revenue Service (IRS) is concerned, those losses cannot be fully realized and offset until you have sold the corresponding investments for a price lower than you originally paid.
What are some of the limitations?
Investors and their advisers should be aware of the wash-sale rule, an IRS regulation implemented to prevent investors from selling their securities at a loss simply to enjoy tax benefits. This rule means that investors aren’t eligible to claim a loss on the sale of a security if they repurchase it (or one that's “substantially identical”) within 30 days. These rules apply to transactions occurring in their spouse’s accounts, too!
If your client’s losses exceed their gains in a given year, they can deduct up to $3,000 a year to offset ordinary income (if married and filing jointly). If filing as an individual, they can deduct up to $1,500.
When should I think about tax-loss harvesting?
While it certainly makes sense to consider tax-loss harvesting immediately prior to the end of the year, at a time when the prospect of filing returns becomes imminent, you might actually want to consider evaluating opportunities throughout the year. As we’ve seen this year, investments can be volatile, and tax-loss harvesting opportunities that presented themselves early in the year might have faded just a few months later.
We hope this provided a helpful introduction to the concept of tax-loss harvesting, and how it can help to ease the pain during periods of downturn or market uncertainty. In future blogs, we’ll be delving deeper into how this practice is particularly helpful in the context of sustainable investing.
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