November 21, 2023 • 25 mins
Tax loss harvesting is a strategy that investors use to reduce their tax bill. However, there are many misconceptions about tax loss harvesting, including when it's valuable and how to do it effectively.
James debunks some of the most common myths about tax loss harvesting and explains how to use this strategy to your advantage.
Questions Answered:
How can investors benefit from tax loss harvesting by offsetting capital gains and ordinary income taxes?
What are the rules and limitations surrounding tax loss harvesting, including the wash sale rule?
Timestamps:
0:00 Intro
3:59 Listener example
6:26 Identify a replacement security
11:17 Example
17:20 Capital losses
20:30 Looking at tax loss harvest
23:44 Intentionally realizing gains
24:25 Outro
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Transcript
Episode Transcript
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Speaker 1 (00:00):
Tax loss harvesting is a strategy that investors use
to reduce their tax bill byselling investments that have
lost value and offsetting thoselosses with gains from other
investments.
However, there are manymisconceptions about tax loss
harvesting, including when it'svaluable and how to do it
effectively.
In today's episode of Ready forRetirement, we'll debunk some
(00:20):
of the most common myths abouttax loss harvesting and help you
understand how to use thisstrategy to your advantage.
This is another episode ofReady for Retirement.
I'm your host, james Kanol, andI'm here to teach you how to
get the most out of life withyour money.
And now on to the episode.
Today's episode comes from alistener question.
(00:41):
This listener's name is Tim,and Tim wrote in this.
He says let's look at ahypothetical John Doe is filing
his taxes married filing jointlywith his wife and then make
$200,000 per year.
John sells his shares of hisABC stock that he held over a
year and makes a $500 profit indoing so.
He owes $75 in long-termcapital gains tax on that sale
(01:03):
because he's in the 15% federallong-term capital gain tax
bracket.
Let's assume he then sells ashare of XYZ stock that he also
held over a year and he loses$100 on that sale.
He can now subtract the $100long-term loss from his $500
long-term profit and he now hasa net gain of $400, which now
(01:23):
means he owes $60 in taxes Inthe end.
Where long-term gains areconcerned, he lost $100 in his
tax-house harvesting effort toreduce his taxes by $15, which
is the difference between $75paid in taxes versus paying only
$60.
Unless you have reasonablecertainty that the new
investment vehicle you reinvestthe money from the sale of XYZ
(01:45):
will yield at least $85, so the$100 you've lost minus the $15
tax benefit, you've still lostmoney.
I've never heard any presenterstate explicitly that tax-house
harvesting still results in netloss.
They mostly go up in a tangentabout wash-sale rules.
A concrete example, as above,of course corrected for any
errors or misunderstandings Ihave about the topic, followed
(02:06):
by discussion of whatcircumstances in which an
investor may reasonably expectto come out ahead employing the
strategy of loss would begreatly valued.
Thank you, tim.
All right, tim.
Well, thank you very much forthat question.
In a sense you know what Tim isasking and I think it's a good
question.
He's saying look, tax-househarvesting has tax benefits.
I don't deny that.
But those tax benefits maybeare very little or they pale in
(02:28):
comparison to the actual lossesthat you're suffering by selling
a stock at a loss.
What am I missing here?
What gives?
Why?
Would this actually be a goodstrategy, assuming that the
losses you're realizing fromselling a stock offset any of
the gains that you're realizingin tax benefits because of that
capital loss?
Tim, good question, and we'regoing to cover that on today's
(02:48):
episode.
Before I do, I want to quicklyhighlight the review of the week
.
This comes from a user namedMFK1970.
They leave a five-star reviewand they save an outstanding
podcast.
Thank you for explainingcomplex concepts in plain
language.
It enables me to better makedecisions and determine what
other questions I need to ask.
You focus on the most criticalissues and provide great
(03:09):
examples.
You have brought comfort andconfidence to my financial
planning.
Thank you Well, mfk1970, thankyou very much for that review.
Thank you to all of you who areleaving reviews.
If you haven't already done so.
It always means a lot to mewhen I see those come through.
If you don't mind taking acouple of minutes, leaving a
five-star review, if you foundany value from this podcast,
sharing this podcast withfriends, family, coworkers,
(03:29):
people who are looking for goodretirement information, would
really appreciate you doing so.
Hopefully they would appreciateyou doing so as well.
Let's now get on with the topic.
Tim, I'll start by saying thisI agree with you A lot of times
tax loss harvesting is poorlyexplained and because of that
it's often misunderstood.
So let's walk through a clearexample of why it works.
(03:53):
And to start, let's look atwhere Tim is right.
And just to quickly summarizeTim's point, he provided an
example.
He said let's assume I sell astock with a $500 gain.
I have to pay taxes on that$500 gain.
Let's also assume I sellanother stock with a $100 loss.
Well, I lose $100.
If I sell a stock, that loss islocked in when I sell In.
(04:14):
The potential tax benefits fordoing so is it offsets $100 of
the gains I otherwise realized.
But that only saves me about$15 in taxes, or exactly $15 in
taxes, if I'm in the 15% federalcapital gain bracket.
So what I can't understand andI'm talking as Tim here what I
can't understand is how wouldanyone think that's a good
(04:35):
trade-off, a guaranteed $100loss, for only a $15 tax benefit
?
Well, here's where I wouldcontinue this, or here's what I
would say you might be missing,tim, is if you just sell the
investment and you don't doanything with it, then you're
exactly right.
You're missing the point of taxloss harvesting.
(04:56):
So you sell your investment,your stock, your mutual fund,
whatever it is, for $100 loss.
That's real money.
That's a real loss.
If you invested $1,000, it'snot worth $900 and you sell it,
you lost $100.
There's no denying that there'sa tax benefit of $15 because
that loss offset gains fromother stock sells, but the loss
(05:16):
still outweighs the gains.
Here's what you're missing,though, tim, is ideally or not
ideally if you're going to beemploying the strategy, you are
simultaneously repurchasing asimilar investment.
That can't be identical.
And so, tim, to your point.
As people start going off ontangents about wash sales, what
a wash sale is is if you sell astock at a loss.
(05:39):
Let's say you own McDonald'sstock and you sell McDonald's at
a loss and you immediatelyrepurchase McDonald's stock.
Well, that's a wash sale.
You can't just lock in thatloss that you can use on your
tax return and then rebuy thesame exact investment
immediately.
That triggers a wash sale.
You have to wait 30 plus daysto repurchase the same
investment, and that's 30 dayseither prior to sale or post
(06:02):
sale, in order to not have anywash sale complications.
So, tim, let's look at what youshould be doing instead of that
.
Now, none of this is arecommendation.
I'm going to use some specificfunds and even some specific
ticker symbols in some of theseexamples.
I want to be very clear thatnone of this should constitute a
recommendation or anendorsement of any type.
We're just using specificexamples to try to make this as
(06:24):
practical as possible.
So the first thing that you'regoing to do when you implement
tax loss harvesting is you needto identify a replacement
security.
So don't just sell somethingbecause it's down in value and
you have some tax benefits to doso.
You need to know where am Igoing to then reallocate those
funds?
Because if you don't reallocatethose funds and you sell a
(06:46):
stock or a fund that has a loss,that's just a loss and there's
no benefit to the strategy foryou.
But if, before you sell, youidentify a replacement, then
ideally what you're doing isyou're continuing to maintain
your overall exposure towhatever investment you are
allocated to, while stillharvesting or taking advantage
of those losses that you can useto write off against other
(07:09):
types of income on your taxreturn.
So, for example, maybe you sellan S&P 500 index if it's gone
down in value.
Well, if you do that, whateverthe loss is, that loss is then
locked in.
You can use that to write offagainst other capital gains.
You can even use that to writeoff against some of your
ordinary income more on thatlater, but that loss is locked
(07:31):
in Now.
What you don't want to do isjust keep that money in cash,
because now it's not going to goup when the investment that you
wanted it to be invested ingoes up.
So you can't buy an identicalsecurity Now.
You can't go sell the VanguardS&P 500 index just to go buy the
Fidelity S&P 500 index, forexample.
That's going to besubstantially identical security
(07:52):
.
But maybe what you do is yousell an S&P 500 index fund, for
example, and you buy a Russell1000 index fund.
Now those are very differentindices but they have a lot of
overlap.
The Russell 1000 index is amarket cap weighted index that
owns the thousand largestcompanies in the United States.
When I say market cap weighted,what I mean by that is it's not
(08:15):
as if the Russell 1000 or theRussell benchmark or the Russell
index looks at the thousandlargest companies and said, okay
, each of you get the sameallotment of money in this fund.
So 0.1% to each stock in theRussell 1000.
Instead, the Russell 1000 issaying it's market cap weighted.
So Apple is the largest company.
Apple is going to have thelargest allocation of a Russell
(08:39):
1000 index.
Microsoft's a large company.
They're going to get a largerallocation.
Google's a larger company.
They're going to get a largerallocation.
So, whatever the percentage ofa specific stock in the index,
that's how much of an allocationit's going to get.
What does that matter?
Well, if you look at the S&P500, it's also market cap
weighted.
It's also going to own Apple,microsoft, google, these larger
(09:02):
companies.
So when you're doing this, it'snot the identical security that
you're purchasing, but the topholdings.
The correlation, the overlap isgoing to be pretty similar
there.
So, generally speaking and thisisn't going to be true 100% of
the time, nor to 100%correlation, or perfect
correlation at least but if theS&P 500 is going up in general,
(09:25):
it's very likely the Russell1000 index will be going up.
So what you want to do is getsomething similar in place of
the investment that you sold andagain, you want something that
has high correlation and highoverlap.
But it's not the exact samething.
So if you have questions about,well, what securities could be
replacement security withoutviolating the wash sale rule,
talk to your CPA, talk to yourfinancial advisor.
(09:47):
But this is something that's animportant component really a
crucial component of the TaxlessHarvesting Strategy.
Hey everyone, it's me again forthe Disclaimer.
Please be smart about this.
Before doing anything, pleasebe sure to consult with your tax
planner or financial planner.
Nothing in this podcast shouldbe construed as investment, tax,
legal or other financial advice.
It is for informationalpurposes only.
(10:09):
I'll walk you through a processwe go through internally.
So, if we're going to doTaxless Harvesting for clients
and, by the way, since thebeginning of 2022, a lot of
investments have gone out ofvalue.
Now, these are never fun times.
It's never something that youhope for as an investor, but
what you should be doing is, ifyou have a brokerage account and
, by the way, I say brokerageaccount because this isn't
something that you would do inan IRA or a 401K or Roth IRA,
(10:32):
where there are no tax benefitsor disadvantages of buying or
selling funds.
It's all tax free, at least taxdeferred but in a brokerage
account, this is where you wantto be taken advantage, ideally,
of some of the market downturns.
So what we do is we have fundsthat we would set aside or that
we would identify for a clientportfolio to say here's the
funds we think make most sensefor your portfolio to accomplish
(10:54):
your unique goals.
We also have replacement fundsfor those funds.
We know ahead of time thatTaxless Harvesting, at some
point at least, is going to be alikely thing that we do for
many clients.
So whatever fund we have, wehave replacement funds that we
say, if we're going to TaxlessHarvest, we know in advance what
fund are we going to harvestinto.
(11:15):
So I'll walk through an example.
Let's assume that we make apurchase for $100,000 in a
client's account into a smallcompany mutual fund or ETF.
I'm going to use Vanguard as anexample, since many people are
familiar with them.
Again, this is not arecommendation, but let's assume
that we purchased $100,000worth of the Vanguard Extended
Market ETF.
So this is a fund that's owningsmall companies and medium
(11:38):
companies here in the UnitedStates.
Well, that fund is based upon aStandard and Poor's index
composition.
So when you look at an indexthe S&P or the Russell 1000 or
the Wilshire 3000 or the FTSEindex these are all indices that
are measuring the market basedupon different types of
composition.
How are they tracking whethersomething's large or small, or
(12:03):
value or growth?
What are they trying to ownbetween large or small, or value
or growth, or international ordomestic, or whatever the case
might be?
So I'll come back to this injust a second.
But going back to the example,if we purchase $100,000 of the
Vanguard Extended Market ETF andthen subsequently small
companies and medium sizedcompanies here in the United
States drop in value, let'sassume that that $100,000 is now
(12:26):
worth $90,000.
Well, if you don't sell itnumber one it's not a loss and
we have hope that it willrecover.
But number two, if you don'tsell it, you're not able to lock
in any of those losses.
There's no tax benefit fordoing so.
So here's what you might thinkabout doing for Taxos Harvesting
when this happens.
Let's assume we sell that fund,we sell the Vanguard Extended
(12:48):
Market ETF and we use that topurchase a different fund.
And let's assume that the fundthat we purchase is called the
Vanguard Russell 2000 Index FundETF.
Now what does that mean?
It means that it's tracking theRussell 2000, which also
happens to be small and mediumcompanies.
So as you're looking at thatyou're getting similar exposure
(13:10):
to the Vanguard Extended MarketIndex, but it's based upon a
different market composition.
Now, I'm not saying this as arecommendation, so talk to your
financial advisor, talk to yourCPA if you actually want to know
if these two funds could bereplacements or if they're too
similar.
But I'm simply using this as anexample to illustrate the point
, because here's what you couldthen do you sell the Vanguard
Extended Market Index, youpurchase the Vanguard Russell
(13:34):
2000.
Index, in this example, forillustrated purposes only, and
that locks in a $10,000 lossthat you can now use on your tax
return, but you've maintainedsimilar exposure.
And Tim, back to your question Ithink this is the missing piece
is you didn't get the benefitjust in terms of now you have a
loss that you can use in yourtax return, but the benefit is
(13:56):
you remain still invested.
You remain invested insomething that, when small
companies or medium companies dorise again, well, you're still
participating in that.
So theoretically, you're notmissing anything, or at least
you're not missing much in termsof the expected recovery, but
you're still able to harvest orreap some of those tax benefits
along the way.
Now here's what you do next.
(14:17):
Let's see what happens next?
Well, from there, does themarket continue going down?
Does a small and medium size UScompany market continue to drop
in the US?
Well, if that's the case, thenafter 30 days, because again,
you can't repurchase a similarsecurity or the same security
within 30 days withouttriggering a wash sale.
But let's assume that the newfund you purchased continues to
(14:40):
drop.
So it goes from 90,000 andlet's assume it drops to 85,000
after 31 days.
Well, now you're in a positionwhere you could actually tax us
harvest again right back intothe original security.
So in that example, you startedwith 100,000.
And that 100,000 was giving youexposure to the exact type of
investment you want exposure tofor your specific goals.
(15:02):
Then it dropped in value, soyou sold that investment and
purchased a similar one to takeadvantage of the tax benefits.
Well, the similar investmentalso dropped in value and the 30
plus day window expired foryour ability to repurchase the
original fund.
Well, great, you sell thereplacement security and get
back into the original one.
And now what's happened is youhave the same allocation you
(15:25):
otherwise would have.
You have the same dollar amountin that allocation that you
otherwise would have.
But now you have $15,000 andlosses that you've harvested
without losing your exposure tothat investment.
That's not always the case,though.
Sometimes, after you do tax usharvesting, the market increases
in value and although that'svery good thing, that's what we
(15:45):
want, of course.
This is why it's reallyimportant that you do the work
upfront to identify thereplacement security, because if
you get in a situation whereyou tax us harvest and do a
replacement security and thevalue that replacement security
rises, in many cases you don'tnecessarily just want to sell
out of that right away for atleast 365 days, because
(16:06):
otherwise you're dealing with ashort-term gain.
So you want to make sure you'rereally comfortable owning that
replacement security,potentially for a good while in
your portfolio, because you mayget stuck in this position where
it increases in value.
You don't want to sell itbecause you don't want to
trigger any short-term gains,but then you start to realize
you know what.
That really wasn't the bestsecurity that I could have
purchased to replace what Ioriginally had.
(16:28):
So, all that to say, make surethat you're doing the work
upfront.
But that's the concept of howit works.
Okay, that was a long-windedexplanation of how this thing
actually works, how the strategyactually works.
Let's now talk about the benefit, because there's some
misunderstood benefits to this,and it can actually be used in
some pretty substantial ways.
So we always have to askourselves why are we doing this?
(16:48):
What's the benefit of it?
Well, number one any lossesthat we realize through capital
loss harvesting can be used towrite off gains.
The way that works is you mayhave short-term losses, you may
have long-term losses.
Both can be used to offsetgains.
The way that it works, though,is any long-term losses must
first be used to offset anylong-term gains.
(17:09):
If there's excess losses aboveand beyond that, then that can
be applied to short-term losses.
Same thing as vice versaShort-term losses must be used
to offset short-term gains first.
So the first benefit is you canuse the losses to write off
capital gains in the same yearthat you realize the losses.
The second benefit is you canactually use up to $3,000 per
(17:31):
year of capital losses to offsetordinary income.
Now, $3,000 is not a hugeamount, but from impact per
dollar perspective, this isactually the bigger benefit.
Let's go back to Tim's questionto illustrate what I mean.
He mentioned someone that had a$200,000 per year taxable
income, married filing jointly.
What a taxable income of$200,000 per year.
(17:54):
Your ordinary income taxbracket would be 24% at the
federal level, but your capitalgains tax bracket would be 15%.
So if given the option, I'drather be able to use capital
losses to write off ordinaryincome and save $0.24 on the
dollar than to use the samecapital losses to write off
capital gains and save $0.15 onthe dollar.
(18:16):
So it would be great if youcould use this to write off
unlimited amounts of ordinaryincome, but you are capped at
$3,000 per year.
So if you have $100,000 peryear of income and let's say you
have $10,000 in losses, you canuse $3,000 of that to write off
your ordinary income and bringthat down to $97,000.
The rest would either need tobe used for capital losses or
(18:39):
carry forward to future years.
And that's another importantpoint Is these capital losses
they don't all have to be usedthis year.
You can actually bank theselosses to use against future
gains.
Here's a practical example ofhow that works out.
We have many clients that willeither sell a business, or
they'll sell a piece of realestate, or they'll sell
something that's not even intheir brokerage account.
(19:00):
Well, in those years, one ofthe things that we're doing from
a strategy standpoint is we'retrying to harvest as much as we
possibly can from theirbrokerage account to offset the
tax impact that selling theirbusiness might have on their
taxes or to offset the impactthat selling a piece of real
estate might have on their taxes.
So capital losses the IRS isn'tnecessarily care about.
(19:22):
Is this a business that yousold?
A piece of property that yousold, a stock that you sold, a
mutual fund that you sold?
They're treated the same way.
A capital loss can be used tooffset a capital gain and
there's no limit to how muchthat can be applied.
And I say no limit because it'ssaid to them the ordinary
income side.
You're limited to writing off$3,000 per year of capital
losses against ordinary income.
(19:44):
Well, if you realize thecapital loss of a million
dollars, you can use that fullmillion dollars up to a million
dollars of capital gains.
There's no limit to how much ofthat can be used in any given
year and any unused losses justcarry forward to future years.
Here's an important note aswell A lot of people will look
at something and maybe, forexample, they started investing
(20:05):
15 years ago and they've justbeen buying a total stock market
index ever since then, andthey'll look at their fund and
they'll say, oh geez, we onlyhave one investment and if you
look at this, we don't reallyhave losses.
What we paid, what we purchased,is significantly less than what
this investment is now worth.
Well, that might be true ifyou're just looking at the total
(20:26):
value of your investmentcompared to the total cost basis
.
But ideally what you're doing,if it makes sense, is you are
looking at tax loss harvest,even at the individual lot level
.
So let's look at an example ofwhat I mean by that.
Maybe you started investing 15years ago.
Every single month you've beenputting money into the same
(20:46):
exact mutual fund ETF stock.
Whatever the case might be,well, that original purchase
probably has a huge gain becausein the last 15 years, the stock
market has grown tremendously.
So you might not want to sellthat specific lot.
So the specific dollars thatyou started with, but any
contributions you've made sincethat time, any dividends that
(21:08):
have been paid and reinvestedsince that time, any one-off
contributions you've made sincethat time, those all have their
own individual tax lots.
So, even if your investment asa whole has gone up in value,
make sure that you're alsolooking at the individual lots
to see are there any losseswithin this fund or the stock or
this position that I can alsosell.
(21:29):
One rule that you need to bevery careful to know as you're
doing all this is you have tocoordinate.
Let's say that you'repurchasing Vanguard's S&P 500
ETF and let's assume thatthere's a loss in that.
Well, you go and you sell thatETF and your tax will count to
realize the loss and you saywell, wait a minute, why don't I
just realize the loss here andthen go to my IRA or my Roth IRA
(21:50):
and purchase the fund there?
So I'm still maintainingexposure.
I'm not violating any wash salerules.
So I think in my brokerageaccount.
Well, in the IRS's eyes you are.
So if you buy that securityanywhere, if you buy it in your
IRA, if you buy it in your RothIRA, if you buy it in another
account that's not tied to thisone, that still violates the
(22:11):
wash sale rule.
And here's actually where peopleget more hung up.
It's within 30 days that youcannot purchase that same
security once you've sold it ifyou want to be able to realize
the losses.
An honest mistake that a lot ofpeople make is they will have
purchased the security 30 daysprior to potentially selling, so
it's not just after you've soldthat you have to wait 30 days,
(22:32):
but if you've even purchasedthat security within 30 days
prior to selling, that alsotriggers a wash sale violation.
So be careful what you dobefore you realize a capital
loss and after you realize acapital loss.
So, as we start to wrap uptoday's episode, one of the
things I want to point out is,while this is a relatively
straightforward strategy and youcan see the benefits of it, it
(22:54):
can be done and there can bemistakes around this.
So make sure you're being verycareful.
And the last thing that I'll sayhere is that realize some years
.
It may actually be morebeneficial to realize gains than
it would be to realize losses,and this is especially more
common in your retirement years.
Here's what I mean by that.
If, in 2023, you file taxes assingle, then you can have
(23:15):
taxable income and, by the way,taxable income is your just a
gross income minus yourdeductions.
If you're single in 2023, thenyou can have taxable income of
up to $44,625 before you pay anyfederal capital gains taxes.
If you're married, finally andjointly in 2023, you can have
(23:36):
taxable income up to $89,250before you pay anything in
federal capital gains.
So if you're under thosethresholds, tax loss harvesting
probably isn't doing anythingfor you.
In fact, it might becounterproductive.
It may be better in thoseinstances to actually be
intentionally realizing gains upto a certain level, because in
(23:57):
many cases you can do that andnot pay any taxes for doing so.
So make sure that you're notjust doing this blindly, make
sure you're not just doing thisbecause you heard it on podcasts
, but make sure you'reunderstanding your strategy,
what your goals are, what yourunique tax situation is, and
then make the decision that'sbest for you.
So, Tim, going back to yourquestion, thank you very much
(24:18):
for providing that.
I hope this was helpful to seehow, yes, there are real
benefits to tax loss harvesting,but you need to be mindful of
your situation first.
Thank you, as always, to all ofyou who are checking in and
listening in.
Make sure you watch us onYouTube as well.
The channel name is JamesCannell.
Please leave a review, ifyou've not already done so
already here on this podcast,and I'll see you all next time.
Thank you for listening toanother episode of the Ready for
(24:42):
Retirement podcast If you wantto see how root financial can
help you implement thetechniques I discussed in this
podcast.
Then go torootfinancialpartnerscom and
click start here, where you canschedule a call to one of our
advisors.
We work with clients all overthe country and we love the
opportunity to speak with youabout your goals and how we
might be able to help.
And please remember nothing wediscussed in this podcast is
(25:03):
intended to serve as advice.
You should always consult afinancial, legal or tax
professional who's familiar withyour unique circumstances
before making any financialdecisions.
Tax loss harvesting is a strategy that investors use
to reduce their tax bill byselling investments that have
lost value and offsetting thoselosses with gains from other
investments.
However, there are manymisconceptions about tax loss
harvesting, including when it'svaluable and how to do it
effectively.
In today's episode of Ready forRetirement, we'll debunk some
(00:20):
of the most common myths abouttax loss harvesting and help you
understand how to use thisstrategy to your advantage.
This is another episode ofReady for Retirement.
I'm your host, james Kanol, andI'm here to teach you how to
get the most out of life withyour money.
And now on to the episode.
Today's episode comes from alistener question.
(00:41):
This listener's name is Tim,and Tim wrote in this.
He says let's look at ahypothetical John Doe is filing
his taxes married filing jointlywith his wife and then make
$200,000 per year.
John sells his shares of hisABC stock that he held over a
year and makes a $500 profit indoing so.
He owes $75 in long-termcapital gains tax on that sale
(01:03):
because he's in the 15% federallong-term capital gain tax
bracket.
Let's assume he then sells ashare of XYZ stock that he also
held over a year and he loses$100 on that sale.
He can now subtract the $100long-term loss from his $500
long-term profit and he now hasa net gain of $400, which now
(01:23):
means he owes $60 in taxes Inthe end.
Where long-term gains areconcerned, he lost $100 in his
tax-house harvesting effort toreduce his taxes by $15, which
is the difference between $75paid in taxes versus paying only
$60.
Unless you have reasonablecertainty that the new
investment vehicle you reinvestthe money from the sale of XYZ
(01:45):
will yield at least $85, so the$100 you've lost minus the $15
tax benefit, you've still lostmoney.
I've never heard any presenterstate explicitly that tax-house
harvesting still results in netloss.
They mostly go up in a tangentabout wash-sale rules.
A concrete example, as above,of course corrected for any
errors or misunderstandings Ihave about the topic, followed
(02:06):
by discussion of whatcircumstances in which an
investor may reasonably expectto come out ahead employing the
strategy of loss would begreatly valued.
Thank you, tim.
All right, tim.
Well, thank you very much forthat question.
In a sense you know what Tim isasking and I think it's a good
question.
He's saying look, tax-househarvesting has tax benefits.
I don't deny that.
But those tax benefits maybeare very little or they pale in
(02:28):
comparison to the actual lossesthat you're suffering by selling
a stock at a loss.
What am I missing here?
What gives?
Why?
Would this actually be a goodstrategy, assuming that the
losses you're realizing fromselling a stock offset any of
the gains that you're realizingin tax benefits because of that
capital loss?
Tim, good question, and we'regoing to cover that on today's
(02:48):
episode.
Before I do, I want to quicklyhighlight the review of the week
.
This comes from a user namedMFK1970.
They leave a five-star reviewand they save an outstanding
podcast.
Thank you for explainingcomplex concepts in plain
language.
It enables me to better makedecisions and determine what
other questions I need to ask.
You focus on the most criticalissues and provide great
(03:09):
examples.
You have brought comfort andconfidence to my financial
planning.
Thank you Well, mfk1970, thankyou very much for that review.
Thank you to all of you who areleaving reviews.
If you haven't already done so.
It always means a lot to mewhen I see those come through.
If you don't mind taking acouple of minutes, leaving a
five-star review, if you foundany value from this podcast,
sharing this podcast withfriends, family, coworkers,
(03:29):
people who are looking for goodretirement information, would
really appreciate you doing so.
Hopefully they would appreciateyou doing so as well.
Let's now get on with the topic.
Tim, I'll start by saying thisI agree with you A lot of times
tax loss harvesting is poorlyexplained and because of that
it's often misunderstood.
So let's walk through a clearexample of why it works.
(03:53):
And to start, let's look atwhere Tim is right.
And just to quickly summarizeTim's point, he provided an
example.
He said let's assume I sell astock with a $500 gain.
I have to pay taxes on that$500 gain.
Let's also assume I sellanother stock with a $100 loss.
Well, I lose $100.
If I sell a stock, that loss islocked in when I sell In.
(04:14):
The potential tax benefits fordoing so is it offsets $100 of
the gains I otherwise realized.
But that only saves me about$15 in taxes, or exactly $15 in
taxes, if I'm in the 15% federalcapital gain bracket.
So what I can't understand andI'm talking as Tim here what I
can't understand is how wouldanyone think that's a good
(04:35):
trade-off, a guaranteed $100loss, for only a $15 tax benefit
?
Well, here's where I wouldcontinue this, or here's what I
would say you might be missing,tim, is if you just sell the
investment and you don't doanything with it, then you're
exactly right.
You're missing the point of taxloss harvesting.
(04:56):
So you sell your investment,your stock, your mutual fund,
whatever it is, for $100 loss.
That's real money.
That's a real loss.
If you invested $1,000, it'snot worth $900 and you sell it,
you lost $100.
There's no denying that there'sa tax benefit of $15 because
that loss offset gains fromother stock sells, but the loss
(05:16):
still outweighs the gains.
Here's what you're missing,though, tim, is ideally or not
ideally if you're going to beemploying the strategy, you are
simultaneously repurchasing asimilar investment.
That can't be identical.
And so, tim, to your point.
As people start going off ontangents about wash sales, what
a wash sale is is if you sell astock at a loss.
(05:39):
Let's say you own McDonald'sstock and you sell McDonald's at
a loss and you immediatelyrepurchase McDonald's stock.
Well, that's a wash sale.
You can't just lock in thatloss that you can use on your
tax return and then rebuy thesame exact investment
immediately.
That triggers a wash sale.
You have to wait 30 plus daysto repurchase the same
investment, and that's 30 dayseither prior to sale or post
(06:02):
sale, in order to not have anywash sale complications.
So, tim, let's look at what youshould be doing instead of that
.
Now, none of this is arecommendation.
I'm going to use some specificfunds and even some specific
ticker symbols in some of theseexamples.
I want to be very clear thatnone of this should constitute a
recommendation or anendorsement of any type.
We're just using specificexamples to try to make this as
(06:24):
practical as possible.
So the first thing that you'regoing to do when you implement
tax loss harvesting is you needto identify a replacement
security.
So don't just sell somethingbecause it's down in value and
you have some tax benefits to doso.
You need to know where am Igoing to then reallocate those
funds?
Because if you don't reallocatethose funds and you sell a
(06:46):
stock or a fund that has a loss,that's just a loss and there's
no benefit to the strategy foryou.
But if, before you sell, youidentify a replacement, then
ideally what you're doing isyou're continuing to maintain
your overall exposure towhatever investment you are
allocated to, while stillharvesting or taking advantage
of those losses that you can useto write off against other
(07:09):
types of income on your taxreturn.
So, for example, maybe you sellan S&P 500 index if it's gone
down in value.
Well, if you do that, whateverthe loss is, that loss is then
locked in.
You can use that to write offagainst other capital gains.
You can even use that to writeoff against some of your
ordinary income more on thatlater, but that loss is locked
(07:31):
in Now.
What you don't want to do isjust keep that money in cash,
because now it's not going to goup when the investment that you
wanted it to be invested ingoes up.
So you can't buy an identicalsecurity Now.
You can't go sell the VanguardS&P 500 index just to go buy the
Fidelity S&P 500 index, forexample.
That's going to besubstantially identical security
(07:52):
.
But maybe what you do is yousell an S&P 500 index fund, for
example, and you buy a Russell1000 index fund.
Now those are very differentindices but they have a lot of
overlap.
The Russell 1000 index is amarket cap weighted index that
owns the thousand largestcompanies in the United States.
When I say market cap weighted,what I mean by that is it's not
(08:15):
as if the Russell 1000 or theRussell benchmark or the Russell
index looks at the thousandlargest companies and said, okay
, each of you get the sameallotment of money in this fund.
So 0.1% to each stock in theRussell 1000.
Instead, the Russell 1000 issaying it's market cap weighted.
So Apple is the largest company.
Apple is going to have thelargest allocation of a Russell
(08:39):
1000 index.
Microsoft's a large company.
They're going to get a largerallocation.
Google's a larger company.
They're going to get a largerallocation.
So, whatever the percentage ofa specific stock in the index,
that's how much of an allocationit's going to get.
What does that matter?
Well, if you look at the S&P500, it's also market cap
weighted.
It's also going to own Apple,microsoft, google, these larger
(09:02):
companies.
So when you're doing this, it'snot the identical security that
you're purchasing, but the topholdings.
The correlation, the overlap isgoing to be pretty similar
there.
So, generally speaking and thisisn't going to be true 100% of
the time, nor to 100%correlation, or perfect
correlation at least but if theS&P 500 is going up in general,
(09:25):
it's very likely the Russell1000 index will be going up.
So what you want to do is getsomething similar in place of
the investment that you sold andagain, you want something that
has high correlation and highoverlap.
But it's not the exact samething.
So if you have questions about,well, what securities could be
replacement security withoutviolating the wash sale rule,
talk to your CPA, talk to yourfinancial advisor.
(09:47):
But this is something that's animportant component really a
crucial component of the TaxlessHarvesting Strategy.
Hey everyone, it's me again forthe Disclaimer.
Please be smart about this.
Before doing anything, pleasebe sure to consult with your tax
planner or financial planner.
Nothing in this podcast shouldbe construed as investment, tax,
legal or other financial advice.
It is for informationalpurposes only.
(10:09):
I'll walk you through a processwe go through internally.
So, if we're going to doTaxless Harvesting for clients
and, by the way, since thebeginning of 2022, a lot of
investments have gone out ofvalue.
Now, these are never fun times.
It's never something that youhope for as an investor, but
what you should be doing is, ifyou have a brokerage account and
, by the way, I say brokerageaccount because this isn't
something that you would do inan IRA or a 401K or Roth IRA,
(10:32):
where there are no tax benefitsor disadvantages of buying or
selling funds.
It's all tax free, at least taxdeferred but in a brokerage
account, this is where you wantto be taken advantage, ideally,
of some of the market downturns.
So what we do is we have fundsthat we would set aside or that
we would identify for a clientportfolio to say here's the
funds we think make most sensefor your portfolio to accomplish
(10:54):
your unique goals.
We also have replacement fundsfor those funds.
We know ahead of time thatTaxless Harvesting, at some
point at least, is going to be alikely thing that we do for
many clients.
So whatever fund we have, wehave replacement funds that we
say, if we're going to TaxlessHarvest, we know in advance what
fund are we going to harvestinto.
(11:15):
So I'll walk through an example.
Let's assume that we make apurchase for $100,000 in a
client's account into a smallcompany mutual fund or ETF.
I'm going to use Vanguard as anexample, since many people are
familiar with them.
Again, this is not arecommendation, but let's assume
that we purchased $100,000worth of the Vanguard Extended
Market ETF.
So this is a fund that's owningsmall companies and medium
(11:38):
companies here in the UnitedStates.
Well, that fund is based upon aStandard and Poor's index
composition.
So when you look at an indexthe S&P or the Russell 1000 or
the Wilshire 3000 or the FTSEindex these are all indices that
are measuring the market basedupon different types of
composition.
How are they tracking whethersomething's large or small, or
(12:03):
value or growth?
What are they trying to ownbetween large or small, or value
or growth, or international ordomestic, or whatever the case
might be?
So I'll come back to this injust a second.
But going back to the example,if we purchase $100,000 of the
Vanguard Extended Market ETF andthen subsequently small
companies and medium sizedcompanies here in the United
States drop in value, let'sassume that that $100,000 is now
(12:26):
worth $90,000.
Well, if you don't sell itnumber one it's not a loss and
we have hope that it willrecover.
But number two, if you don'tsell it, you're not able to lock
in any of those losses.
There's no tax benefit fordoing so.
So here's what you might thinkabout doing for Taxos Harvesting
when this happens.
Let's assume we sell that fund,we sell the Vanguard Extended
(12:48):
Market ETF and we use that topurchase a different fund.
And let's assume that the fundthat we purchase is called the
Vanguard Russell 2000 Index FundETF.
Now what does that mean?
It means that it's tracking theRussell 2000, which also
happens to be small and mediumcompanies.
So as you're looking at thatyou're getting similar exposure
(13:10):
to the Vanguard Extended MarketIndex, but it's based upon a
different market composition.
Now, I'm not saying this as arecommendation, so talk to your
financial advisor, talk to yourCPA if you actually want to know
if these two funds could bereplacements or if they're too
similar.
But I'm simply using this as anexample to illustrate the point
, because here's what you couldthen do you sell the Vanguard
Extended Market Index, youpurchase the Vanguard Russell
(13:34):
2000.
Index, in this example, forillustrated purposes only, and
that locks in a $10,000 lossthat you can now use on your tax
return, but you've maintainedsimilar exposure.
And Tim, back to your question Ithink this is the missing piece
is you didn't get the benefitjust in terms of now you have a
loss that you can use in yourtax return, but the benefit is
(13:56):
you remain still invested.
You remain invested insomething that, when small
companies or medium companies dorise again, well, you're still
participating in that.
So theoretically, you're notmissing anything, or at least
you're not missing much in termsof the expected recovery, but
you're still able to harvest orreap some of those tax benefits
along the way.
Now here's what you do next.
(14:17):
Let's see what happens next?
Well, from there, does themarket continue going down?
Does a small and medium size UScompany market continue to drop
in the US?
Well, if that's the case, thenafter 30 days, because again,
you can't repurchase a similarsecurity or the same security
within 30 days withouttriggering a wash sale.
But let's assume that the newfund you purchased continues to
(14:40):
drop.
So it goes from 90,000 andlet's assume it drops to 85,000
after 31 days.
Well, now you're in a positionwhere you could actually tax us
harvest again right back intothe original security.
So in that example, you startedwith 100,000.
And that 100,000 was giving youexposure to the exact type of
investment you want exposure tofor your specific goals.
(15:02):
Then it dropped in value, soyou sold that investment and
purchased a similar one to takeadvantage of the tax benefits.
Well, the similar investmentalso dropped in value and the 30
plus day window expired foryour ability to repurchase the
original fund.
Well, great, you sell thereplacement security and get
back into the original one.
And now what's happened is youhave the same allocation you
(15:25):
otherwise would have.
You have the same dollar amountin that allocation that you
otherwise would have.
But now you have $15,000 andlosses that you've harvested
without losing your exposure tothat investment.
That's not always the case,though.
Sometimes, after you do tax usharvesting, the market increases
in value and although that'svery good thing, that's what we
(15:45):
want, of course.
This is why it's reallyimportant that you do the work
upfront to identify thereplacement security, because if
you get in a situation whereyou tax us harvest and do a
replacement security and thevalue that replacement security
rises, in many cases you don'tnecessarily just want to sell
out of that right away for atleast 365 days, because
(16:06):
otherwise you're dealing with ashort-term gain.
So you want to make sure you'rereally comfortable owning that
replacement security,potentially for a good while in
your portfolio, because you mayget stuck in this position where
it increases in value.
You don't want to sell itbecause you don't want to
trigger any short-term gains,but then you start to realize
you know what.
That really wasn't the bestsecurity that I could have
purchased to replace what Ioriginally had.
(16:28):
So, all that to say, make surethat you're doing the work
upfront.
But that's the concept of howit works.
Okay, that was a long-windedexplanation of how this thing
actually works, how the strategyactually works.
Let's now talk about the benefit, because there's some
misunderstood benefits to this,and it can actually be used in
some pretty substantial ways.
So we always have to askourselves why are we doing this?
(16:48):
What's the benefit of it?
Well, number one any lossesthat we realize through capital
loss harvesting can be used towrite off gains.
The way that works is you mayhave short-term losses, you may
have long-term losses.
Both can be used to offsetgains.
The way that it works, though,is any long-term losses must
first be used to offset anylong-term gains.
(17:09):
If there's excess losses aboveand beyond that, then that can
be applied to short-term losses.
Same thing as vice versaShort-term losses must be used
to offset short-term gains first.
So the first benefit is you canuse the losses to write off
capital gains in the same yearthat you realize the losses.
The second benefit is you canactually use up to $3,000 per
(17:31):
year of capital losses to offsetordinary income.
Now, $3,000 is not a hugeamount, but from impact per
dollar perspective, this isactually the bigger benefit.
Let's go back to Tim's questionto illustrate what I mean.
He mentioned someone that had a$200,000 per year taxable
income, married filing jointly.
What a taxable income of$200,000 per year.
(17:54):
Your ordinary income taxbracket would be 24% at the
federal level, but your capitalgains tax bracket would be 15%.
So if given the option, I'drather be able to use capital
losses to write off ordinaryincome and save $0.24 on the
dollar than to use the samecapital losses to write off
capital gains and save $0.15 onthe dollar.
(18:16):
So it would be great if youcould use this to write off
unlimited amounts of ordinaryincome, but you are capped at
$3,000 per year.
So if you have $100,000 peryear of income and let's say you
have $10,000 in losses, you canuse $3,000 of that to write off
your ordinary income and bringthat down to $97,000.
The rest would either need tobe used for capital losses or
(18:39):
carry forward to future years.
And that's another importantpoint Is these capital losses
they don't all have to be usedthis year.
You can actually bank theselosses to use against future
gains.
Here's a practical example ofhow that works out.
We have many clients that willeither sell a business, or
they'll sell a piece of realestate, or they'll sell
something that's not even intheir brokerage account.
(19:00):
Well, in those years, one ofthe things that we're doing from
a strategy standpoint is we'retrying to harvest as much as we
possibly can from theirbrokerage account to offset the
tax impact that selling theirbusiness might have on their
taxes or to offset the impactthat selling a piece of real
estate might have on their taxes.
So capital losses the IRS isn'tnecessarily care about.
(19:22):
Is this a business that yousold?
A piece of property that yousold, a stock that you sold, a
mutual fund that you sold?
They're treated the same way.
A capital loss can be used tooffset a capital gain and
there's no limit to how muchthat can be applied.
And I say no limit because it'ssaid to them the ordinary
income side.
You're limited to writing off$3,000 per year of capital
losses against ordinary income.
(19:44):
Well, if you realize thecapital loss of a million
dollars, you can use that fullmillion dollars up to a million
dollars of capital gains.
There's no limit to how much ofthat can be used in any given
year and any unused losses justcarry forward to future years.
Here's an important note aswell A lot of people will look
at something and maybe, forexample, they started investing
(20:05):
15 years ago and they've justbeen buying a total stock market
index ever since then, andthey'll look at their fund and
they'll say, oh geez, we onlyhave one investment and if you
look at this, we don't reallyhave losses.
What we paid, what we purchased,is significantly less than what
this investment is now worth.
Well, that might be true ifyou're just looking at the total
(20:26):
value of your investmentcompared to the total cost basis
.
But ideally what you're doing,if it makes sense, is you are
looking at tax loss harvest,even at the individual lot level
.
So let's look at an example ofwhat I mean by that.
Maybe you started investing 15years ago.
Every single month you've beenputting money into the same
(20:46):
exact mutual fund ETF stock.
Whatever the case might be,well, that original purchase
probably has a huge gain becausein the last 15 years, the stock
market has grown tremendously.
So you might not want to sellthat specific lot.
So the specific dollars thatyou started with, but any
contributions you've made sincethat time, any dividends that
(21:08):
have been paid and reinvestedsince that time, any one-off
contributions you've made sincethat time, those all have their
own individual tax lots.
So, even if your investment asa whole has gone up in value,
make sure that you're alsolooking at the individual lots
to see are there any losseswithin this fund or the stock or
this position that I can alsosell.
(21:29):
One rule that you need to bevery careful to know as you're
doing all this is you have tocoordinate.
Let's say that you'repurchasing Vanguard's S&P 500
ETF and let's assume thatthere's a loss in that.
Well, you go and you sell thatETF and your tax will count to
realize the loss and you saywell, wait a minute, why don't I
just realize the loss here andthen go to my IRA or my Roth IRA
(21:50):
and purchase the fund there?
So I'm still maintainingexposure.
I'm not violating any wash salerules.
So I think in my brokerageaccount.
Well, in the IRS's eyes you are.
So if you buy that securityanywhere, if you buy it in your
IRA, if you buy it in your RothIRA, if you buy it in another
account that's not tied to thisone, that still violates the
(22:11):
wash sale rule.
And here's actually where peopleget more hung up.
It's within 30 days that youcannot purchase that same
security once you've sold it ifyou want to be able to realize
the losses.
An honest mistake that a lot ofpeople make is they will have
purchased the security 30 daysprior to potentially selling, so
it's not just after you've soldthat you have to wait 30 days,
(22:32):
but if you've even purchasedthat security within 30 days
prior to selling, that alsotriggers a wash sale violation.
So be careful what you dobefore you realize a capital
loss and after you realize acapital loss.
So, as we start to wrap uptoday's episode, one of the
things I want to point out is,while this is a relatively
straightforward strategy and youcan see the benefits of it, it
(22:54):
can be done and there can bemistakes around this.
So make sure you're being verycareful.
And the last thing that I'll sayhere is that realize some years
.
It may actually be morebeneficial to realize gains than
it would be to realize losses,and this is especially more
common in your retirement years.
Here's what I mean by that.
If, in 2023, you file taxes assingle, then you can have
(23:15):
taxable income and, by the way,taxable income is your just a
gross income minus yourdeductions.
If you're single in 2023, thenyou can have taxable income of
up to $44,625 before you pay anyfederal capital gains taxes.
If you're married, finally andjointly in 2023, you can have
(23:36):
taxable income up to $89,250before you pay anything in
federal capital gains.
So if you're under thosethresholds, tax loss harvesting
probably isn't doing anythingfor you.
In fact, it might becounterproductive.
It may be better in thoseinstances to actually be
intentionally realizing gains upto a certain level, because in
(23:57):
many cases you can do that andnot pay any taxes for doing so.
So make sure that you're notjust doing this blindly, make
sure you're not just doing thisbecause you heard it on podcasts
, but make sure you'reunderstanding your strategy,
what your goals are, what yourunique tax situation is, and
then make the decision that'sbest for you.
So, Tim, going back to yourquestion, thank you very much
(24:18):
for providing that.
I hope this was helpful to seehow, yes, there are real
benefits to tax loss harvesting,but you need to be mindful of
your situation first.
Thank you, as always, to all ofyou who are checking in and
listening in.
Make sure you watch us onYouTube as well.
The channel name is JamesCannell.
Please leave a review, ifyou've not already done so
already here on this podcast,and I'll see you all next time.
Thank you for listening toanother episode of the Ready for
(24:42):
Retirement podcast If you wantto see how root financial can
help you implement thetechniques I discussed in this
podcast.
Then go torootfinancialpartnerscom and
click start here, where you canschedule a call to one of our
advisors.
We work with clients all overthe country and we love the
opportunity to speak with youabout your goals and how we
might be able to help.
And please remember nothing wediscussed in this podcast is
(25:03):
intended to serve as advice.
You should always consult afinancial, legal or tax
professional who's familiar withyour unique circumstances
before making any financialdecisions.
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