🌾Tax-Loss Harvesting What and How in December?

I don’t know about you but prior to 2021, I haven’t heard of half of these terms that have taken the investment world by storm.

Ryan Serhant, luxury real estate realtor and owner of Serhant predicts in 5 years 50% of real estate sales will be transacted through crypto and digital real estate will be the norm.

As Kenan Thompson would say, “What’s up with that?!”

It never gets old.

In other news, NFT is apparently the word of the year. I prefer Fauci.

If still confused on what the tea is on NFTs, check it out here.

Though I cannot promise you you still won’t be confused.

Without further or due, the most ubiquitous confusing investment terms of 2021 include:

-Crypto
-Stable coins
-Blockchain
-Dogecoin
-Stonks
-Meme stocks such as Gamestop or BlackBerry (I was born in 2000)
-Short squeeze
-BTS
-NFTs

Last but not least, tax-loss harvesting.

I know. Harvesting? Tax-loss? We like tax-loss but harvesting? We don’t want to harvest the loss, right? What???

I’m a simple gal. I’m 21 and don’t have patience for any textbook jargon. Until recently I realized the tax-loss harvesting strategy is not only a beneficial way for investors to offset their capital-gains tax bill, but the best time to do so is towards the end of the year! Today!

Tax-Loss Harvest Has Sprouted

To improve overall portfolio returns and mimimize the tax burden, investors have often turned to tax-loss harvesting at the end of the year. This entails selling (liquidating) securities that have lost value and using those losses to help offset one’s capital-gains tax liability. Investors report this as a capital loss when they fill out their yearly income taxes. Any unrealized loss, losses that aren’t sold, cannot be deducted from your income taxes.

Wash-Sale Rule

This rule, established by the IRS prohibits investors from selling a security at a loss, then buying it again, then realizing those tax losses through a reduction in capital gains. You cannot sell or trade securities within 30 days of the sale to buy an identical investment. This rule is in place to prevent taxpayers to claim artificial losses in order to minimize their taxes. The sale within a 30-day timeframe would violate this rule.

Realized gains is when an investment is sold for a higher price than what it was purchased for. Once an investment is sold, it is subject to capital gains tax. If it’s been purchased and growing but not realized (sold), it is unrealized.

A way to legally avoid violating the wash-sale rule is to sell an investmnet and buy a similar security as we will dive into below.

The reason for performing a wash-sale goes beyond tax liability constraints. As investors, we strive to derive the maximum return from our investments. The best way to do so is by caclulating risk, having a balanced portfolio, and staying diversified.

An investor will tend to want to replace a poor perfoming security with a similar security which would allow them to maintain an optimal balanced asset allocation yet it is imperative they are aware of the wash-sale rule.

You may be wondering, can an unrealized loss have tax benefits?

Yes. To realize the loss, it must bea loss and at that point it can be used for tax deductible purposes which can be used to offset capital gains.

If an investor decides to go about perfomring a tax-loss harvesting strategy, they need to be mindful that they do not accidentally trigger the wash sale in their investment account. In addition, investors (married) who file jointly may be able to claim up to $3k in capital losses per year, $1500 filing individually to be able to offset their taxable income.

Benefits of Harvesting

Now obviously this sounds appealing to 99.9%+ of investors since over 80% of Americans don’t pay taxes but how can we generate a profit from tax-loss harvesting?

Since less than half of Americans are invested, the rest believe in various myths about the stock market which include but not limited to:

-Too time consuming

-Not enough funds avaliable

-No investing background

Yada yada.

Unless Americans are forced to change, such as during a pandemic, sadly they won’t and prefer to earn W2 income, and pay more taxes than a billionare.

Thankfully, tax-loss harvesting is here to save the day. This isn’t an obvious reason to invest but can help encourage many as investors have saved upwards of billions through this strategy. Another way to bypass taxes is to forever buy and hold, move to a more efficient taxable state and be neighbors with billionares, own a tax-depreciating/deductible business, real estate, and contribute the max to your tax advantageous accounts such as a 401(k) and Roth IRA. Although passive investing is a prudent foolproof no maintenance path, many investors cannot deal with the patience game since they prefer to liquidate their holdings several times a year to fund their lavish lifestyle. In that case, they must follow other tax strategies listed.

Pick your poison. Pay more taxes each year for immediate cash and perform tax-loss harvesting or just wait while passively diversified and eventually you’ll meet Buffett.

It’s unfortunate Americans don’t want to fufill their civic duty and responsibility to give back to Uncle Sam. Yet, I completely understand where the frustration lies within the government. Even Nancy Pelosi encourages insider trading!

Until we see change in our country, Americans will be reluctant on paying their dues. Yet the reason for such a high non-tax payer percentage is due to the fact that a majority of those in the top 10% and above, who own the most collective wealth in this country, are business and home owners. Paradoxically, the richest Americans get the most tax brakes due to their income breakdown. Maybe the IRS is advocating we all become business owners?

To be clear, owning a business doesn’t only entail managing a unicorn from Silicon Valley that just went public. Anything that generates positive cash flow from a blog to a restaurant that is not W2 income from an employer counts. In order to improve the country and lower the government deficit, tax hikes must be in place or the government needs to reduce its spending which has always been difficult as everything seems to be broken. The government is reliant on the top 1% who can donate a small fraction of their wealth away and revitalize the economy.

Business owners can get by on paying zero income, wealth and or property taxes because they report themselves to the IRS in the lowest marginal tax bracket. Whatever their take-home annual salary may be, they reinvest it all back into their business and keep whatever they need to survive. Those who earn equity-based-compensation have their paychecks tied to their stock price movements and can choose to cash out/vet whenever they please and at that time, they pay taxes on their gains. Otherwise, any investment, property, or appreciable asset can sit there forever tax-free.

Essentially the more rebalancing, selling, and changes you make within your portfolio, the more you end up giving away.

No wonder billionaires are selling their massive stakes in their companies these days. Before the marginal tax bracket hikes up for those in 37%+ bracket and stock market correction hits with continuing inflationary, omicron variant concerns, and Fed tapers, billionaires and CEOs alike are taking advantage of this massive bull rally.

Tax-Loss Harvests

Now that we’ve covered how Americans skip out on paying taxes and harvesting all together, let’s uncover the portfolio boost an investor, most likely day/active trader, would generate from selling their holdings through this approach.

On average an investor facing a capital-gains tax rate of over 20% can actually increase their equity portfolio’s annual return by over 1 to 2 percentage points with tax-loss harvesting.

This is possible since the value that can be added is even greater when markets are more volatile since it produces more loosing stocks. An example of this happening was around the time when the Fed was planning on becoming more hawkish or simply when an investor is selling short-term holdings.

This doesn’t mean you want to sell your holdings to purely pay no taxes. That would be a foolish move since markets consistently go up yoy. Tax-loss harvesting is mainly done by day traders or investors with individual holdings. They see a prime opportunity when their holidays aren’t going in the direction they hoped they would and they wuld prefer to cash out to offset their capital gains requirement now than wait for it to possibly retreat and earn a profit but pay income-tax on top.

Harvest Season

It is recommended to not harvest more than half your portfolio in a particular year.

Overall, the more volatility and price swings, the more opportune time to engage in harvesting since losses are more prevalent. If investors follow this, they on average see their returns increase by 1 percentage point. At least it’s something. Rarely is anything guaranteed in the markets!

When the stock market is having a down year, this is the most opportune time as tax-loss harvest losses can yield to about 3 percentage points of additional return to one’s equity portfolio yet it can be done anytime as there is always volatility even during a raging bull market as we’ve witnessed these past 13 years. As the Santa Clause rally is around the corner and the S&P 500 is at record highs reaching over 67 records this year alone up 25% yoy, this doesn’t mean there hasn’t been volatility.

Volatility, personal circumstances, and your capital gains rates should all be taken into consideration before offsetting your tax liability.

Investors facing high short-term capital gains, taxed at the income tax level, would find the most benefit from tax-loss harvesting. Alongside these traders, high-income earners who plan on turning over winning stocks to thier heirs can take advantage of this tax exemption as well participating in the step-up basis.

Recap:

-Investors tend to tax-loss sell towards the end of the year and when volatility strikes but it is optional whenever you choose to capture tax losses through rebalancing or replacing positions within your portoflio

-If you are heavily weighted within a position, get out before it’s too late

-Remember that $3k per year can be used to offset other taxable income for a married couple filing jointly and up to $1500 for an individual. Don’t abuse the power.

We all make mistakes, especially in the markets and need to realign our portfolios occasionally. Not every stock will become a unicorn. Take advantage of tax-loss harvesting before tax season rolls around if you must.