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Tax-Loss Harvesting – A Silver Lining of Market Downturns, but Not a Silver Bullet
Published Date : July 25, 2019
Tax-loss harvesting has been a major topic of conversation the past few years as strong equity returns have left portfolios with sizable unrealized gains. Opportunities to offset capital gains have presented themselves, as witnessed by last year’s severe market decline in December and the resulting frenzied activity to capture losses. While offsetting capital gains with capital losses usually makes good sense, it’s important to separate the benefits from the misconceptions and to understand that there are some potential risks. As with most good things, one approach does not fit all. Let’s step back for a moment to understand the basic pros, cons and misconceptions surrounding the strategy.
Harvesting losses is the colloquial term for the process of selling securities with current losses to tactically offset any realized gains taken in a given calendar year. The IRS allows this practice to occur as long as the security sold is not repurchased within 30 days of the sale date. This is known as the wash-sale rule. One approach followed by many investors wishing to maintain existing allocations while avoiding triggering the wash sale is to replace the sold security with a similar, but not identical, position in order to retain investment exposure during the 30-day period. This process of offsetting gains with losses is typically beneficial because it enables active portfolio management while serving to smooth out gains and losses from one year to the next, reducing the impact from high appreciation years, such as the above-average returns experienced in 2017.
It is important to acknowledge that some benefits are commonly inferred, but not always factual. For example, harvesting losses does not necessarily eliminate all taxable gains, but rather defers it into the future. While tax deferral is usually advantageous, since deferring taxes allows for the compounding growth of an investment, an individual’s tax bracket can vary significantly from year to year and potentially offset this assumed advantage. That is, at times it might be more sensible to simply realize the gain rather than possibly deferring it to another tax year. Also, tax-loss harvesting carries some inherent risk that the replacement investment used during the 30-day holding period is inferior. Replacement securities cannot be identical and therefore can potentially perform quite differently than the intended long-term investment. A related current dilemma facing some who aggressively harvested losses at the end of 2018 is how to address the significant market rebound since then. For those investors who simply harvested losses and opted to wait 30 days without investing in any replacement investment, they likely missed out on the strong rally in the first few weeks of 2019. For others who harvested losses and purchased proxy positions for the 30-day period, the decision looms about whether or not to sell the substitute positions, thus realizing short-term gains, or just continue to hold them for more than one year to enable more favorable long-term capital gain tax treatment, but risk possible underperformance along the way.
At Sand Hill, we generally believe that modest and opportunistic harvesting throughout the year can potentially be beneficial to smoothing out the variable year-over-year impact of capital gains; although we also take into consideration any specific significant tax-loss carryforwards or coming expectations of high tax years in the near future. Typically, tax-loss harvesting should not be done automatically or pursued too aggressively, because this can result in overly frequent trading without proper financial and tax planning input. Be cautious of oversimplified or overstated benefits of tax-loss harvesting, and always discuss the matter with your professional team.
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Information provided in written articles are for informational purposes only and should not be considered investment advice. There is a risk of loss from investments in securities, including the risk of loss of principal. The information contained herein reflects Sand Hill Global Advisors' (“SHGA”) views as of the date of publication. Such views are subject to change at any time without notice due to changes in market or economic conditions and may not necessarily come to pass. SHGA does not provide tax or legal advice. To the extent that any material herein concerns tax or legal matters, such information is not intended to be solely relied upon nor used for the purpose of making tax and/or legal decisions without first seeking independent advice from a tax and/or legal professional. SHGA has obtained the information provided herein from various third party sources believed to be reliable but such information is not guaranteed. Certain links in this site connect to other websites maintained by third parties over whom SHGA has no control. SHGA makes no representations as to the accuracy or any other aspect of information contained in other Web Sites. Any forward looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. SHGA is not responsible for the consequences of any decisions or actions taken as a result of information provided in this presentation and does not warrant or guarantee the accuracy or completeness of this information. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of SHGA.
Video Presentations
All video presentations discuss certain investment products and/or securities and are being provided for informational purposes only, and should not be considered, and is not, investment, financial planning, tax or legal advice; nor is it a recommendation to buy or sell any securities. Investing in securities involves varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular client’s financial situation or risk tolerance. Past performance is not a guarantee of future returns. Individual performance results will vary. The opinions expressed in the video reflect Sand Hill Global Advisor’s (“SHGA”) or Brenda Vingiello’s (as applicable) views as of the date of the video. Such views are subject to change at any point without notice. Any comments, opinions, or recommendations made by any host or other guest not affiliated with SHGA in this video do not necessarily reflect the views of SHGA, and non-SHGA persons appearing in this video do not fall under the supervisory purview of SHGA. You should not treat any opinion expressed by SHGA or Ms. Vingiello as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of general opinion. Nothing presented herein is or is intended to constitute investment advice, and no investment decision should be made based solely on any information provided on this video. There is a risk of loss from an investment in securities, including the risk of loss of principal. Neither SHGA nor Ms. Vingiello guarantees any specific outcome or profit. Any forward-looking statements or forecasts contained in the video are based on assumptions and actual results may vary from any such statements or forecasts. SHGA or one of its employees may have a position in the securities discussed and may purchase or sell such securities from time to time. Some of the information in this video has been obtained from third party sources. While SHGA believes such third-party information is reliable, SHGA does not guarantee its accuracy, timeliness or completeness. SHGA encourages you to consult with a professional financial advisor prior to making any investment decision.
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