Harvesting tax losses (“tax swaps”) involves selling one asset at a loss then buying a similar but not “substantially identical” replacement. The swap leaves your portfolio looking the same—but lets you claim a deduction for the loss on your original asset. You can use swaps with individual stocks, bonds, and mutual funds. For example, you can swap one municipal bond for another, one computer manufacturer for another or one growth fund for another. You can use short- and long-term losses to offset unlimited gains, and you can deduct up to $3,000 in capital losses against ordinary income ($1,500 for married couples filing separately.)
For example: On January 3, you buy 100 shares of Starsky Growth Fund at $100 each. On June 30, those shares are worth $80 each. You sell to realize $2,000 in taxable loss, and then reinvest the $8,000 proceeds in the Hutch Growth Fund.
Tax loss harvesting can be emotionally hard. Investors are reluctant to sell their loses because it means admitting a mistake. But recent research suggests that tax loss harvesting boosts after-tax returns significantly. This suggests that regular tax-loss harvesting should be a part of every taxable investor’s plan.
If you, your spouse, or a corporation you control replaces the original investment with a substantially identical security (or a contract or option to acquire a substantially identical security) within 30 days before or after your sale, your loss is disallowed as a wash sale.
- To keep your investment but still realize a loss, consider “doubling up,” or buying an identical lot more than 31 days before selling your old lot.
- It’s not clear how similar two mutual funds can appear before becoming “substantially identical.” It would be aggressive to swap one S&P 500 index fund for another—but not to swap an S&P 500 fund for a Russell 1000 fund.
- The IRS doesn’t explicitly prohibit you from using an IRA, qualified plan, or trust to avoid the wash sale rule by selling a holding from a taxable account, replacing it in the IRA, qualified plan, or trust, then claiming the loss in the taxable account. However, the “related party” rules suggest that this would be an aggressive strategy.
- If you use separate accounts to manage your money, make sure your managers communicate. Otherwise, one manager’s buys could jeopardize tax losses from another manager’ sales.
If you like index or exchange-traded funds, you can still use swaps for components of the index. For example, international investors can buy diversified funds tracking several countries, leaving no opportunity to harvest single-nation losses. Or they can buy a basket of single-country funds and harvest losses within that basket to boost overall after-tax returns.
If you have any questions regarding how tax losses harvesting works in your investments, please do not hesitate to contact us.