Well, it is that time of year. While many are thinking about turkey, pumpkin pie, stockings hung by the chimney with care and all that jazz, it is the time of year that I look at tax loss harvesting.
Tax loss harvesting can be done several different ways. But before we get there, what is it and why would you need to do it?
For those who are still earning a decent income, any short held sales that have capital gains are taxed out at ordinary income levels. Stocks (I am keeping it simple) held less than a year fall under this short term holding rule. Lets use for an example someone taxed at the top income bracket, 39.6% for the feds. If they had a $50,000 short term gain, they would instantly lose $19,800 of that gain to the taxman. Ouch.
This same person, if the holding is held for more than a year loses $10,000 on the $50,000 gain. You can see from this math that 20% is the capital gains tax on long term capital gains for top income earners. Still ouch, but not as bad.
I have sectors in my portfolio where I hire a manager who runs part of my money. I typically do this in sectors where I want to invest to be diverse, but don’t know anything about. International is one sector. These guys are paid to beat benchmarks, not worry about tax gains. And most of the time, the gains are short term.
To offset any of these gains, I need to look at the portion of the portfolio that I control to see if I can take some tax losses.
As I mentioned earlier, there are few different ways to do this. You can simply look at a holding if it is down, sigh, sell, and take the loss. These losses then offset the gains you had elsewhere (I am simplifying but this post can’t be fifteen thousand words). I don’t typically do this as there are reasons I have holdings and most are long term.
Another thing you can do is sell the holding, and then buy it back. BUT BE CAREFUL. There is a 30 day “wash rule”. So if you are taking a bath on WMT for instance, you can’t sell it and buy it right back that same day and receive the tax loss. You have to wait 30 days. This entails a bit of gambling, as you don’t want the holding to skyrocket in the meantime.
I prefer to sell a holding and purchase a different holding in the same sector. While the Walmart example above isn’t a great one for this, here is one that I just did.
I took a bath on BCX this year, a commodity/energy closed end fund. When it came to mid November, I carefully checked the ex-dividend date (I always want to make sure I get a payment if I can), sold BCX and then simply purchased a different energy based closed end fund. That way I am still fully invested in the sector, and have received the tax loss to apply where needed. In this case, I chose NTG. While it isn’t the same as BCX, I am big on gas and the timing was right. It is still an energy sector play and that was good enough for me to not knock out my allocation model.
This same exact strategy can be done with stocks. As in the WMT example above, if you are high on retail, you can buy TGT, or any of the others in the space. And if you get a month out (outside of the wash rule) and things aren’t looking the way you want, you can sell back the TGT and re-buy WMT, and get the tax loss and be on your way. But again, you are gambling just a bit with price, although a month is a drop in the bucket if you are an investor and not a trader.