Optimizing Investing Through Tax-Loss Harvesting

Brandon R. Amaral, CFP®, EA
Brandon R. Amaral, CFP®, EA

Founder & Financial Planner, Amaral Financial Planning

When it comes to investing, there are so many factors to consider:

  • What allocation should you have?
  • What funds should you use?
  • What fees make sense?
  • How do you pay less taxes?

While most advisors have their own investment philosophies and management methods, a widely agreed upon strategy is Tax-Loss Harvesting. Whether you are working with a CFP®, robo-advisor, or managing your investments yourself, incorporating tax-loss harvesting can help optimize your financial plan.

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Here is an overview of Tax-Loss Harvesting:

What is it?

Tax-Loss Harvesting is an investment strategy where you take advantage of market downturns in order to reduce your tax bill. By triggering investment losses, you are able to deduct them against your gains or ordinary income. The less taxable income you have, the less taxes you will owe in April.

Why is it important?

Bull markets, bear markets, economic growth, and recessions – these are normal cycles of the economy. While we all hope for the market to go up, we know that it will sometimes go down. It’s inevitable!

Tax-Loss Harvesting is a great way to still benefit even when the market is down. For example, let’s say you have a $500,000 portfolio and company stock options that you exercised for $0.50 a share. If the market is down 10%, you could potentially harvest $50,000 of losses. You could then use these losses to offset $50,000 of your gains from selling your appreciated company stock. In this example, you could have saved $15,000 – $20,000 in taxes just from tax-loss harvesting.

How is it done?

While the concept is fairly simple, the process itself can be taxing (failed dad joke):

  1. Sell the stock when it is at a loss
  2. At the same time, you purchase a similar stock
  3. After 30 days, you can swap out the new stock for the original one

What counts as similar? A common example is Coca-Cola and PepsiCo. They are both similar companies in similar industries, but are different stocks.

What’s the catch?

The first major mistake that do-it-yourselfers make is waiting to get back into the market. If the market rebounds before you can reinvest, then you can miss out on vital gains and delay reaching your goals. To be clear, Tax-Loss Harvesting is NOT timing the market.

The other critical error is triggering the Wash-Sale rule. Set by the IRS, the Wash-Sale rule states that you can not purchase a substantially identical stock within 30 days of realizing the loss. If you do, your loss will be disallowed and the entire process will need to start over again.

Tax-Loss Harvesting is a great strategy to improve your investments and reduce your tax bill. If you would like to work with a financial planner to walk you through your options, I would love to help you!

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Disclaimer: This blog is for informational purposes only, and should not be considered advice or recommendations. All opinions expressed herein are solely those of Amaral Financial Planning, LLC, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made to another parties’ informational accuracy or completeness. You should consult your financial advisor, tax professional or legal counsel prior to implementation.