Reshaping your portfolio through tax-loss harvesting can help it grow toward your goals
N
obody likes taking losses in the
market, but there is a way to
turn it into a gain. As part of a
carefully considered tax mitigation and
portfolio rebalancing strategy, those
losses can have greater value than it
may seem if you focus only on the red ink.
Tax-loss harvesting – selling stocks,
bonds, mutual funds and other investments that have declined since you
purchased them – can be especially
important if you’re in a higher tax bracket.
While it’s always been true that it’s not
what you make but what you keep that
matters, at current rates the combined
tax liability (federal plus state and local
taxes) on ordinary income, nonqualified
dividends and short-term capital gains
can easily top 50% for high-income taxpayers. And while taxes on long-term
gains are lower (counting the 3.8%
Medicare surtax, the highest effective
long-term capital gains tax is 23.8%),
they’re definitely still significant.
Although your individual tax strategy
is something to be worked out with your
financial advisor and tax professional,
the key takeaway for most investors is
to minimize net gains whenever possible.
As featured in
That means looking long and hard at your
losers, being realistic about their chances
of recovery, and possibly selling them to
offset gains that could otherwise result
in a hefty tax bill.
Think short-term first
Many investors plan to hold on to their
securities for at least a year as part of
a long-term financial plan, but sometimes it’s necessary to sell a short-term
holding. Since short-term gains (investments held for one year or less) are taxed
at the higher marginal rate, you should
aim first at reducing those through taxloss harvesting. The tax code specifies
that short- and long-term losses must
be used first to offset gains of the same
type. However, if your losses of one type
exceed your gains of the same type, you
can apply any excess to the other type.
In other words, if you have $10,000 in
long-term capital gains and $20,000
in long-term losses, you can use the
Up to $3,000 a year
in net capital losses
can be used to reduce
ordinary income
$10,000 difference to offset short-term
capital gains.
Remember too that realizing a capital
loss can be worthwhile even if you don’t
expect to have short- or long-term gains
in 2015. Up to $3,000 a year in net capital
losses can be used to reduce ordinary
income, including that from nonqualified dividends. If you still have capital
losses after applying them first to capital
gains and then to ordinary income, you
can carry them forward and use them in
future years.
Making adjustments
After six-plus years of rising stock prices,
many investors are sitting on large potential gains – and may also have seen their
intended portfolio mix drift away from
their original plan. For example, a portfolio meant to contain a 60/40 weighting
of stocks to bonds might now be at 70/30 –
off balance because of stock price appreciation. Similarly, disproportionate gains
in one or more sectors may have left
your portfolio too heavily invested
in those industries. Rebalancing –
bringing the overall portfolio back in line
with your original 60/40 allocation and
a balanced weighting among sectors –
WORTHWHILE, a quarterly periodical dedicated to serving the clients of Raymond James advisors and affiliated advisory firms.
probably means taking some profits.
Taking losses can help here by reducing
your overall gains.
In considering which losses to harvest, remember not to let the tax tail
wag the investment dog. The long-term
investment strategy you and your advisor
have decided on should remain intact
afterward. At the same time, don’t
be sentimental or engage in wishful
We learn
by examining our
errors, determining why
we made them, and figuring
out how to avoid them in
the future.
thinking when reviewing your losers.
If you can’t make a convincing case for
owning the stock, you may want to sell
it. There are always other opportunities.
Plan carefully
While tax planning should be an ongoing
effort, it’s important to think ahead
about any potential capital gains tax
liability well before the end of the
year. Tax-loss harvesting and portfolio
rebalancing should be carried out in an
unhurried and judicious fashion, not on
a last-minute basis. Be sure to keep
your records up to date so you can
determine your exact cost basis
for any security you’re considering
selling, especially anything you may
have owned for a long time.
About wash sales
If you sell a security at a loss but
purcha se anot her “subs t ant ial ly
ident ical” secur it y – w ithin 30
days before or after the sale date –
the IRS likely will consider that a “wash
sale” and disallow the loss deduction. And
no, you can’t sell the stock at a loss in a
taxable account and buy it within that
61-day window in your 401(k) or IRA – the
IRS looks at all your accounts in determining whether a wash sale has occurred.
Reaping what you sow
While nobody buys a stock intending to
generate a loss, it happens more often
than we would like. That leads us to
another benefit of taking our losses –
Continued on next page
Tax considerations
While everyone’s tax situation is different, here are some general guidelines that may be helpful in determining
the financial impact of tax-loss harvesting. Before making any decisions, however, be sure to consult your financial
advisor and tax professional.
For most taxpayers
The Medicare surtax
For those with taxable income between $74,900 and
$464,850 (married, joint filers) and $37,450 and $413,200
(single filers) – the long-term capital gains rate is 15%.
This tax is levied on “unearned income,” which is defined
as investment income, such as income from interest,
dividends, annuities, royalties, capital gains and other
passive income. The surtax applies to taxpayers 1) who
have unearned income and 2) whose modified adjusted
gross income (MAGI) exceeds $250,000 (married joint
filers), $125,000 (married filing separately) and $200,000
(single filers). If those two conditions are met, the 3.8%
surtax applies to the amount of the investment income,
or if smaller, the difference between the taxpayer’s MAGI
and the limits listed above.
High-income taxpayers
Those with taxable income of more than $464,850 (married joint filers), or $413,200 (single filers), are normally
subject to a marginal rate for long-term capital gains of
at least 20%. Above those levels, some taxpayers are
also subject to the 3.8% Medicare surtax, which brings
their effective long-term capital gains rate to 23.8%.
23.8% | The highest
effective long-term capital
gains tax (if including the
3.8% Medicare surtax)
The top tax is 39.6%
The top tax bracket is 39.6% for ordinary income, nonqualified dividends and short-term capital gains. With
the Medicare surtax, the effective rate can now be as
much as 43.4%. State and local income taxes can make
the top effective rate significantly higher.
reflecting on why they occurred in the
first place. It’s said that good judgment
comes from bad judgment – we learn
by examining our errors, determining
why we made them, and figuring out
how to avoid them in the future. In
this case, reviewing the reasons why an
investment you thought would appreciate instead did the opposite can be
especially helpful as you decide how and
where to redeploy the proceeds of your
sales. Happy harvesting!
There is no assurance that any investment
strategy will be successful. Investing involves
risk and investors may incur a profit or a loss.
Asset allocation does not ensure a profit or
protect against a loss.
So what’s the bottom line?
Kimberly has $200,000 of employment income and
$40,000 of net investment income from a capital gain
she took earlier in the year. That puts her modified
adjusted gross over the threshold for the Medicare
surtax on unearned income (the threshold is $200,000
for single filers, $250,000 for joint filers). Kimberly
will owe an additional 3.8% Medicare contributions
tax on the $40,000 of net investment income.
Bottom line | By selling any investments that are
at a loss by year-end, Kimberly not only reduces the
amount of capital gains tax due, but she also reduces
the amount of net investment income exposed to the
Medicare tax.
Employment income = $200,000
Net investment income = $40,000
Taxable amount over MAGI = $40,000
x 3.8%
1,520
$
Steve and Carol are in the 28% marginal tax bracket and
have $10,000 in long-term capital gains and $23,000
in long-term losses. They also have $10,000 in shortterm capital gains.
Bottom line | The long-term losses will save them
$1,500 in long-term capital gains tax (at the 15%
on the $10,000 gain) and will also save them $2,800
they would have owed on the short-term capital gain
(28% marginal tax rate on $10,000). Additionally, the
remaining $3,000 of long-term losses can be used to
reduce the couple’s income this year, saving them
another $840 in taxes.
Breakdown:
Short-term
Long-term
Gains
$10,000
$10,000
Losses
$0
$23,000
Net
$10,000
-$13,000
Overflow
-$3,000
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