Harvesting the Silver Lining

Personal Money Planning |


By Gary Silverman, CFP®

We introduced the basics of saving taxes on your investments that have gone down. This exercise, called tax loss harvesting, is the silver lining in an otherwise dismal market. Sometimes, though, you should just leave well enough alone. We’ll discuss that today.

To review, tax loss harvesting is when you sell a security that has a net loss in order to realize the loss on your taxes. These losses can be used to offset other gains or to shield some ordinary income from taxation. Since you likely own the security because you believe in its future, you immediately replace it with one very similar to it. If only that specific security will do, then you would replace the exact one 30 days before or after the tax loss sale. (For more discussion of this, see last week’s column.)

While this might sound like a great idea, it’s important to realize that while you are getting the tax loss now, you are building in a bigger future tax bill. Here’s why. Let’s say the Netflix stock you bought for $4,700 is now worth only $1,700. Selling it now locks in that $3,000 loss which will give you some nice tax savings. However, we’ll assume you still think Netflix is a good stock to own, so you buy it back several weeks later (avoiding the wash-sale rules discussed last week). For our purposes, let’s assume you buy it back at the same $1,700 price you sold it for.

Now, five years later in 2027 you look at your brokerage statement and see that Netflix is now worth $8,700. Yes! From your initial purchase of $4,700, you made $4,000 in profit. It’s time to take a cruise, so you sell off your stock and enjoy the western Caribbean.

Come tax time, you realize you’re not going to pay taxes on a $4,000 gain: You’ll be paying taxes on a $7,000 gain. Remember that $3,000 loss you took? It not only gave you a nice tax savings; it also reset your cost basis when you rebought the stock. So, as you can see, tax loss harvesting tends to delay taxes, not get rid of them.

Still, that might not be a bad thing; especially if you use the current tax savings to invest more money or if your current tax bracket is higher than your future one.

There’s another potential benefit as well: You might die. Okay, most of you may not think of that as a benefit, but under current tax rules, your heirs will have your lowered cost-basis reset to the value of the stock at the time of your death. If you’re “lucky”, you can have your tax deduction now and possibly have no one pay taxes on the subsequent gains.

This, like all other tax matters, are more complicated than I make them. Make sure you consult your tax advisor before doing anything you might end up regretting.