Investor PhD: Harvesting Losses and Avoiding Gains

Contributed by: Angela Palacios, CFP® Angela Palacios

This may sound counter-intuitive, but taking some measures to harvest tax losses on positions and avoiding unnecessary capital gains distributions this time of year can go a long way in improving your net (after tax) returns.

Make sure you are reviewing your portfolio throughout the year for tax losses to harvest.  Stock losses were at their peak during mid-February, but if you waited until this fall to think about tax loss harvesting you have most likely missed the boat as much of those losses have been recovered and moved on to higher highs. The end of the year is rarely the best time of the year to harvest tax losses. 

Harvesting losses doesn’t mean you are giving up on the position entirely. When you sell to harvest a loss you cannot have had a purchase into that security within the 30 days prior to and after the sale.  If you do you are violating the wash sale rule and the loss is disallowed by the IRS. Despite these restrictions, there are several ways you can carry out a successful loss harvesting strategy.

Loss harvesting strategies:

  • Sell the position and hold cash for 30 days before re-purchasing the position. The downside here is that you are out of the investment and give up potential returns (or losses) during the 30 day window.

  • Sell and immediately buy a position that is similar to maintain market exposure rather than sitting in cash for those 30 days. After the 30 day window is up you can sell the temporary holding and re-purchase that original investment.
  • Purchase the position more than 30 days before you want to try to harvest a loss. Then after the 30 day time window is up you can sell the originally owned block of shares at the loss. Being able to specifically identify a tax lot of the security to sell will open this option up to you.

Common mistakes some people make when harvesting:

  • Dividend reinvests count!!! So if you think you may employ this strategy and the position pays and reinvests a monthly dividend you may want to consider having that dividend pay to cash and just reinvest it yourself when appropriate or you will violate the wash sale rule.
  • Purchasing a similar position and that position pays out a capital gain during the short time you own it.
  • Creating a gain when selling the fund you moved to temporarily that wipes out any loss you harvest. Make the loss you harvest meaningful or be comfortable holding the temporary position longer.
  • Buying the position in your IRA. This will violate the wash sale rule just like if you bought it in your taxable account. This is identified by social security numbers on your tax filing. So any accounts held under those same tax payer IDs are not allowed to purchase the security in that 30 day window of harvesting the losses.

Personal circumstances vary widely so it is critical to work with your tax professional and financial advisor to discuss more complicated strategies like this!

Angela Palacios, CFP® is the Director of Investments at Center for Financial Planning, Inc.® Angela specializes in Investment and Macro economic research. She is a frequent contributor The Center blog.

The information contained in this blog does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Angela Palacios and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.