Tax-loss Harvesting

Tax-loss selling is a common tax planning strategy. Harvesting a loss generates current tax savings. Even if a position that is harvested for a loss is then later sold at a gain, there is an opportunity for tax deferral in the meantime, which can create a modest economic benefit. A loss now produces additional dollars to use, invest and grow that are not paid to taxes. The benefits of tax-loss selling may be enhanced if there is a potential that gains in the future will be taxed at a lower tax rate than if realized today.

With the strong market environment that has prevailed, with a few interruptions since early 2009, some investors may not have tax-loss candidates. However, there are areas that have lost ground sometime in 2016, for example European stocks during the Brexit events this summer. More recently, a rise in interest rates caused bond prices to fall over the month of November. These are two areas where Heritage identified tax-loss opportunities for clients in certain instances.

Tax-loss harvesting may be maximized with portfolios that are checked frequently for losses. Trying to harvest losses only at year-end can miss out on even greater intra-year events. Reviewing a portfolio regularly throughout the year creates more opportunity to actually sell at the point of maximal loss. Still, because many funds report taxable distributions only at year-end, December tends to have more activity in evaluating holdings for tax purposes.

Some research has suggested that tax-loss harvesting could increase after-tax returns by more than 1.55% a year. This appears to be with aggressive assumptions to market the potential benefit of a specific trading strategy. Other expert analysis has found the benefit of tax-loss selling at 0.20% to 0.42% a year in additional annualized return, depending on tax rate and time period. Because of this somewhat modest benefit, it is important for an investment manager such as Heritage to weigh the risks of tax-loss selling, including transaction costs and finding an appropriate replacement investment to hold after the sale.

Although the exact value may be difficult to quantify, the bottom line is that tax-loss harvesting can provide a benefit for many taxpayers via tax-deferral and compounding growth, potentially over a long period of time. As fiduciaries of our clients’ assets, we incorporate tax-aware management that aims to include thoughtful tax-loss selling strategies when the opportunity exists.

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