Tax Loss Harvesting - Friend or Foe?

Personal Money Planning |

By Gary Silverman, CFP®

I covered tax loss harvesting earlier in the year (at least I think I did…too lazy to check). However, because it is close to the end of the year, and many of you likely still have some losses in your portfolio from what happened in 2022, I thought I would recap my thoughts today given you have less than two weeks to act.

Tax Loss Harvesting is where you sell off one of your investments so you can capture the loss for your tax return and lower the bill you owe to Uncle Sam. It does not mean it was a bad investment, but you merely hope to “realize” those losses. Two main caveats: first, this is done in a taxable account. Tax losses do not matter for your tax return for IRAs, whether Traditional or Roth. (Okay, there is one way this can be done in an IRA, but circumstances where it works are rare, and it’s something your accountant can tell you about).

Second, since you still think the investment is a good idea (it’s just on sale now), you will want to re-invest in the same fund (you need to wait 30 days—check the IRS rules). Alternatively, you can buy something similar. If it’s not too similar, you can buy the replacement investment the minute you sell the “loser” (again, check the IRS rules).

But my column today is less about how to do tax loss harvesting and more about whether you should care about it.

“Well, it’s obvious, Gary! I will save taxes, so I should do it.”

Not always, my reader friend. (May I call you friend?) You may end up paying more in taxes in the long run. Tax loss harvesting does not eliminate taxes, but rather moves them to different tax years. Let’s say you buy X-Corp for $20 and now it’s worth $15. You sell it and lock in a $5 tax loss. Yay!

Loving the stock, you buy it again in a month when it’s still sitting at $15. Five years from now, your investment acumen is rewarded as X-Corp is selling for $40. Now you decide to sell it and owe taxes on the $25 gain ($40 minus $15). Of course, you already received a $5 loss, so your net gain was $20 ($25 gain minus the original $5 loss). If you had not done the tax loss harvesting, you would owe taxes on that same $20 ($40-$20).

What you should get from the example is that your gain/loss did not change. What did change is what year the gain or loss was realized. And that’s where the planning needs to come in. What does your tax situation look like now versus what you think it will be in the future. Is it better to get a break now and pay more later or to let things ride and not increase your future potential tax burden?

Answer that (we use a computer program because math is hard) and you will know whether to take advantage of your losses now or let your brilliant investment choices ride.

May God Protect the Innocents around the world.