Tax Loss Harvesting

Taxes are a complicated topic and when I discuss taxes on this blog I start with the caveat that you should do your own research and each situation is unique.

All else being equal, stocks in the name of the kids, up to a certain point, are tax favored. Due to the small size of the portfolios and the fact that the kids don’t have a lot of income coming in from other sources, they generally are in low tax brackets.

If you ignore the impact of commissions (buys and sells) one strategy would be to “step up” the basis of stocks every year where you have sales for losses by selling some winners. At the time when the beneficiary starts to sell the stocks in the portfolio to fund some useful purpose (like a down payment on a home), the selling price at the time they sell will be compared to the cost basis (what we paid for it) and then they would have a gain (hopefully) or a loss (if it is worth less than we paid for it). Given that these portfolios have an expected life of greater than a decade hopefully they should be worth more when cashed out then the purchase price.

Since tax losses don’t have much financial value to kids in low tax brackets without other income, a strategy every year when you sell stocks for losses (because of poor future performance predictions, such as with Nokia which was sold across the portfolios) is to look for stocks that have appreciated when you don’t see a lot more gains on the horizon and sell the stocks with gains to “net out” against the losses. Then, when you re-invest the proceed from the stocks that have gained, your tax basis will be equal to the higher amount.

In future posts I will go through the examples and I will be watching this in December because I have losses in 2010 from sales of about $800 in portfolios 1 and 2 and $500 in portfolio 3 and some appreciated stocks. I won’t just sell appreciated stocks for tax reasons, however, if I think they are still going to go up because I don’t want tax policy overriding investment decisions. But if I think a stock has had a good run, “stepping up” the basis by selling winners to match losers (since I can’t use the tax loss) makes sense.

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5 thoughts on “Tax Loss Harvesting”

  1. I like having “losses” in the gun, so to speak for future use. Back when the market WAY oversold in ’08 I took some huge losses on paper on stocks I knew would come back, then just re-bought them after the wash-out rule had expired. It has come in immensely handy since in the past year or so the market is generally up. I had a few assets that were up bigtime, and having the paper losses there to offset these big gains helped immensely.

    Of course with this you get into a time value of money discussion, but that might be a little advanced for the purposes of this blog.

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  2. The funny thing is that the “time value of money” is probably about zero given that interest rates are near enough to zero that you aren’t getting anything back from your investment unless you are taking on risk.

    Of course the real “time value of money” is the risk that you WON’T get the cash flows in the first place; that riskiness is embedded in the discount rate.

    Great strategy for you to sell and carry forward losses. I am trying to be tax efficient with the portfolio by selling and offsetting but I don’t want to impact performance too much. Right now things are going well because the whole damn market is going up not because I am any sort of genius 🙂

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