As the end of the year approaches, you are likely thinking of plans for the upcoming holidays and new year. We encourage you to also be thinking about year-end tax strategies that could potentially reduce your overall tax liability. One possible strategy to consider is a tax-mitigation strategy known as tax-loss harvesting.
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Tax-loss harvesting is electing to sell an investment that is currently at a loss—meaning, the current value of that security has fallen below your original purchase price—in order to capture the loss for tax purposes. Once you have sold the investment at a loss, you will then be able to either use that capital loss to offset capital gains in the current tax year or carry forward the loss to offset gains in future tax years. Additionally, if there are not any capital gains to offset in any given year, most taxpayers can use up to $3,000 of the captured loss to offset ordinary income such as salary income or interest income. You can carry capital gain losses forward indefinitely until the losses are all used up.

Once you have sold the security and captured the loss for tax purposes, you should invest the proceeds back into a very similar security to maintain your portfolio’s overall asset allocation and risk profile, which also keeps your money invested and working for you.

For example, let’s assume that two investors each invest $30,000 in an investment at the beginning of the year and that their individual tax rates are the same, 20% for long-term capital gains and 30% for short-term capital gains and ordinary income. Let’s also assume that both of their investments have fallen by 10% for a $3,000 decline in value.

In this scenario, the first investor (A) decides to do nothing with their investment, instead choosing to hold the investment for the potential future appreciation. However, the second investor (B) chooses to sell their investment for $27,000, realizing the $3,000 loss. Investor B will be able to use this $3,000 loss to offset ordinary income for the year, effectively saving $900 of income tax when calculated at a 30% tax rate. Investor B then reinvests the $27,000 from the sale of this original investment, and also invests the $900 from the tax savings, placing a total of $27,900 back into the market.

Assume that no further purchases nor any further sales of investments take place, and both investors hold the investments until they have doubled in value from the point of the 10% decline. At that time, when the investments have doubled in value, investor A sells their investment for $54,000 and investor B sells their investment for $55,800.

Investor A, selling their investment at $54,000, has achieved a $24,000 long-term capital gain that will be taxed at 20%. This means that the after-tax result will be $49,200, for a total return of 64% on the original $30,000 investment.Investor B, selling their investment at $55,800, has achieved a $27,900 long-term capital gain. At a 20% capital gain tax rate, her after-tax results will be $50,200, for an 80% total return on her investment of $27,900.

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While anyone can implement this strategy, it is important to be aware of the wash-sale rule that, if violated, will result in the loss being disallowed by the IRS. We recommend consulting with your tax professional as well as working with your financial advisor if you are not confident executing tax-loss harvesting on your own.
Now let’s switch from the hypothetical to the practical and review how The Mather Group, LLC (TMG) implements tax-loss harvesting for our clients and avoids violating the wash-sale rule.
First off, TMG takes a “rules-based” approach to our tax-mitigation strategy. This rules-based approach applies human-made rules to algorithmic systems that are evaluating the cost and pricing differences as markets move. More specifically:
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Individual portfolios and securities are monitored on a daily, weekly, or monthly basis to identify potential tax-loss harvesting candidates. Using TMG’s rules, this leverages an automated process at this initial level.

Tax-loss harvesting candidates then must meet or exceed a specific dollar or percentage minimum value to be considered further. This rule assures that potential trading costs, if any, do not detract from achieving the tax-loss harvesting goals.

Similar – but not identical – securities are identified to replace the potential tax-loss harvesting candidate, assuring that a portfolio’s existing asset allocation mix and risk profile are not changed in any significant way, maintaining the desired risk tolerance.

Once approved, the tax-loss harvesting sale and purchase occur within 1 to 2 days, assuring that client portfolios retain their existing level of market exposure.

Tax-loss harvesting results are maintained in TMG’s portfolio management system and then reported to custodians for year-end reporting purposes.

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