Independent Thinking^®

Tax-Loss Harvesting: A Silver Lining in a Down Market

Tax-loss harvesting means selling an investment at a loss to offset capital gains. Over the last 20 years, it’s been applied to stocks, which tend to be more volatile than bonds. But the recent and severe bond market dislocation has provided investors with harvesting opportunities in both markets.
 
Quite simply, this means selling shares of a loss-making security and applying the loss against realized gains taken in other investments. Critically, the security must not have been purchased under 31 days before the sale, or repurchased in under 31 days after the sale. Repurchasing in under 31 days triggers what is known as a wash sale and negates the realized loss for tax purposes.
 
The most straightforward approach is simply selling the investment at a loss, be it a mutual fund, an exchange traded fund, a stock, a bond, or another investment. By selling and realizing the loss and keeping the proceeds in cash, assuming the wash sale rule is respected, the loss can be used against realized gains.
 
Alternatively, the loss-making investment can be swapped for a similar, albeit not identical investment, such as a closely correlated index fund or individual security, to maintain the overall asset allocation. It’s important to note that the newly purchased security must be sufficiently different from the sold security; for instance, selling one S&P 500 index fund and buying another would trigger a wash sale, as would selling and buying the same fund or security through different investment vehicles. For a bond tax-loss swap to avoid the wash sale rule, it must have at least two of the three following characteristics: a different issuer (name of the issuing entity); a different coupon; and a different maturity. This rule provides the bond manager enough flexibility to take tax losses across a bond portfolio and avoid wash sale rules, while maintaining the basic duration, liquidity, and credit quality of the portfolio.
 
Keep in mind that gains and losses incurred on investments held less than a year are taxed at higher rates than those on longer-term investments. There can also be transaction costs to consider.
 
Efficient tax-loss harvesting requires careful planning and close consultation with your portfolio manager and tax advisor. But the right tactical moves, in the context of a well-thought-out investment strategy, can help support the long-term goals of income and capital appreciation, even at the end of a very challenging year.
 
Michael Kirkbride is a Managing Director and Portfolio Manager at Evercore Wealth Management. He can be contacted at michael.kirkbride@evercore.com. To learn more about tax-loss harvesting, please view Michael’s recent video at https://www.evercorewealthandtrust.com/tax-loss-harvesting-pros-cons/.