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Amid stock market volatility, many investors are seeking portfolio protection. But they could be missing a prime tax planning opportunity, experts say.
The strategy, known as tax-loss harvesting, is selling losing assets from a brokerage account to offset other investing gains to lower taxes. Losses are typically used to offset gains, such as those from investment sales or capital gains distributions from mutual funds or exchange-traded funds.
Once losses exceed profits, you can subtract up to $3,000 from regular income. After that, you can carry excess losses into future tax years indefinitely.
“It’s looking for a silver lining on a pouring, rainy, cloudy day,” said certified financial planner Sean Lovison, founder of Philadelphia-area Purpose Built Financial Services.
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Investors should weigh tax-loss harvesting opportunities anytime there’s stock market volatility, experts say.
“That should be throughout the year,” said Lovison, who is also a certified public accountant.
Tax-loss harvesting could be attractive with the S&P 500 Index still down more than 15% from an all-time high in February as of midday Tuesday. The index briefly entered bear market territory — more than 20% off its record — during Monday’s session amid tariff uncertainty.
Here are some key things to know about tax-loss harvesting, financial advisors say.
You need a ‘very granular’ strategy
While tax-loss harvesting sounds simple, the current market pullback requires a “very granular” approach, according to CFP Judy Brown at SC&H Group in the Washington, D.C., and Baltimore area.
After many years of market growth, investment losses could include more recent purchases, said Brown, who is also a certified public accountant. She has been busy identifying specific “tax lots,” which are transaction records showing an asset’s purchase date and price.
You need systems to “quickly find those lots” to sell for the tax-loss harvesting benefit, Brown said.
Know the ‘wash sale’ rule
One of the perks of tax-loss harvesting is that you can sell assets for a loss and reinvest a similar investment to maintain exposure, Lovison said.
But you need to know about the “wash sale rule,” which blocks the tax break for buying a “substantially identical” asset within 30 days before or after the sale, according to the IRS.
While individual stocks may be easy, there’s less IRS guidance on how “substantially identical” applies to mutual funds and ETFs, experts say.
For example, you could sell one large cap fund family for another from a different family when the holdings are slightly different, Lovison said.
But if you’re repurchasing the same exact index holding identical funds, “that might not pass the [IRS] sniff test,” he said.
