The light is at the end of the tunnel. In less than two months, we can wish good riddance to the pandemic and election stress-filled year 2020. While I would not blame investors for wanting to bury their heads in the sand for the rest of the year, there are still potential year-end tax saving moves to consider.
No one invests to lose money, but losses obviously can and do occur. With the market turbulence this year, there is a good chance you have losses in certain investments in your taxable account. If you haven’t already, you should consider realizing those losses in your taxable accounts. They help you save on taxes in 3 ways. First, you can use those losses to offset capital gains realized from other securities. That is important as they help offset or negate the tax cost of rebalancing a taxable portfolio. Second, if you have more losses than gains, up to $3,000 of those losses can be treated as a deduction off your income. Finally, remaining losses carry forward into future years.
To realize a loss, you simply need to sell the security. You can then buy something else or wait 31 days to repurchase the same security to avoid the wash rules. We utilize loss harvesting strategies for our clients and think you should consider this strategy too, at least once per year, and more often during very volatile time periods.
Even if you do not sell any securities, you may still end up with capital gains. That is because mutual funds and ETFs that you hold may end up distributing gains, regardless if you want them or not. Even worse, a fund could end up paying a taxable capital gain to you when you are negative. The payments are not something you can control, but there is something you can do about it. Funds usually, but not always, pay their capital gains in the latter part of the year, November and December. Since they also generally publish estimates and payment dates of the gains before they pay them, you can sell the fund before it distributes the gain and avoid the associated taxes completely.
You may be thinking, “wait, don’t I want the gain payment?” The answer is no. The value of the payment reduces the value of the fund. It’s six of one, half a dozen of the other. It’s the same amount of value, either way; just one of them makes you pay taxes.
When we look at tax avoidance for clients, we look at the gain or loss since the purchase. Then we look at the estimated distribution from the fund and make a decision. Sometimes the best option is to hold the investment and take the distribution, and sometimes it isn’t. There is a bit of legwork to gather the various funds’ estimates, but ever since Al Gore invented the internet, the information is generally out there.
I believe we should pay our fair share in taxes, but I certainly don’t want to leave Uncle Sam a tip. I also believe we should take advantage of all the legal ways to reduce taxes. Harvesting losses and avoiding unnecessary gain payments are one of those ways and should be a regular strategy you employ to manage your accounts.
This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.