Time-worthy tactics: Tax Loss Harvesting
September 01, 2009

Time-worthy tactics: Tax Loss Harvesting

September brings more than a new school year to mind; with 2010 right around the corner, it’s time to start thinking about tax loss harvesting again. The tactic, which involves selling securities at a loss, is one of the best ways to offset or eliminate taxes on your portfolio gains---especially since earnings on short-term capital gains are taxed at your full federal and state tax rate, unlike the break you get for long term gains that are held for more than one year.

Even though you probably did a lot of tax loss harvesting last year and perhaps have some losses left over that you are going to carry forward, think about adding more losses to your personal balance sheet. ‘The more, the better’ when it comes to saving money on taxes.

Depending on how you look at it, this could mean up to a 38% savings on your money

If you have leftover losses from last year, you can carry them forward to future years, so you always want to be thinking of maximizing your supply of losses. Now, think about your future tax rates, the consensus is that we are going to see higher taxes going forward. If you are in a 35% federal and 3%Illinois state tax bracket now, every dollar that you can protect from taxes in 2009 means up to$.38 remains in your pocket. Instead of netting out only .62 for $1.00 earned you get the full $1.00, so you are actually saving 38%. Most people would be thrilled to get that kind of return from their investment portfolio. And more so in future years since the consensus is that the economy and the stock market will both grow slowly in the future.

Perhaps you have your portfolio invested just the way you want it, but some of your investments---although doing much better this year--still have losses? You need to be careful of the wash sale rules, where the IRS disallows a loss deduction from the sale of a security if a ‘substantially identical security' was purchased within 30 days before or after the sale.

This is where creativity comes in. The wash sale rule does not prevent the purchase of an exchange-traded fund (or ETF, which is a fund that tracks the performance of an underlying index) as a “placeholder” for a mutual fund or another ETF. Since most of our clients are invested in ETFs, we can do this as long as the ETFs are based on different indexes.

So when does it make sense to harvest tax losses from an investment? While the end of the year is the time most investors review their portfolios for potential tax losses, it’s a strategy that can and should be used year-round because it means more money in your pocket. And it is something we can help you do. But all said, it is important to remember that a well-constructed portfolio that is generating consistently healthy returns is still the mainstay for any long-term investor, and a goal we endeavor to help you attain. Tax considerations are important, but they are secondary to building a solid financial plan and healthy portfolio.

Susan Templeton

September 2009